Bull vs. Bear on What's Next for Silver

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Hard Assets Investor submits:

By Laura Crigger

For our first "Bulls & Bears" 2011 feature on Hard Assets Investor, we turn to a hot topic over the past few months: silver. Although gold nabs most of the headlines, it's silver that has truly outperformed - the metal's price soared an astonishing 84 percent last year, beating 30-year highs and sparking questions about a possible impending bubble.

Can silver rise even further?

For the bullish perspective, we turned to David Morgan, the founder of
Silver-Investor. com and editor-in-chief of the monthly precious metals research guide, "The Morgan Report." A frequent voice on HAI, Morgan is one of silver's most vocal bulls, and has spent more than 30 years educating investors about opportunities in this often-overlooked metal.

For the bearish view on silver, we spoke with Jim Lowell, chief investment strategist at Adviser Investments and editor of the Fidelity Investor newsletter. Lowell is an outspoken and prolific author, lecturer and commentator on the topic of investing, particularly with ETFs, and his market views and opinions have appeared in dozens of outlets, including Bloomberg, MarketWatch, CNBC, Forbes and Fox Business News.

How their views differ may surprise you - but not as much as where they agree.

BULL: David Morgan: Correction Coming, But $40/oz Silver By Year-End

Hard Assets Investor: We hear a lot of chatter these days about gold being near a bubble. But in 2010, we saw silver's price rise more than 80 percent. Should we be asking instead whether silver is overheated?

David Morgan, editor of The Morgan Report : Well, from which context? On a very short-term basis, I would say yes. Anything that goes up almost 80 percent in just a few short months, you've got to question whether or not it can sustain that type of momentum.

From a short-term perspective, it's probably going to need time to catch its breath back and consolidate, etc. But from a historic perspective, it's far, far from where I expect it to go on a longer term. In other words, I expect it to fly far higher than $30 going out two, three years from now.

HAI: We're still way below the inflation-adjusted high, right?

Morgan: Precisely. As good as it's been - and it's been great; an 80 percent rally is fabulous - but in 1979 to 1980, silver made a 450 percent gain from August to January. It went up six times quicker than it just did. That doesn't mean we'll see a repeat but if you want to know what a bubble looks like, that's the one.

HAI: Are silver prices right now supported by fundamental supply and demand? Last year we saw a 64 million oz. surplus in the market, so what's pushing prices up?

Morgan: Well, it depends how you define it. The two best studies in the world found that all mining activity and recycling (supply) together is greater than all demand. So that would obviously say a surplus. But remember, there was a deficit for 16 straight years. And if you look at it from the perspective of gold, the amount of gold that's above ground would take care of demand for 40 years, where silver might have six months.

The point is, the amount of demand for silver has continued to increase other than the financial crisis years - basically '09. Investment demand continues to be greater and greater every year.

So, to answer the question, "Are fundamentals supporting the price of silver?" The answer's yes.

And the fundamentals support silver more so than gold from the industrial standpoint. Say I am Dow Chemical ( DOW ), DuPont ( DD ) or another silver user. I don't warehouse much of it anymore, since everybody uses just-in-time inventory. Silver's been to $30/oz and then it gets back down to $25/oz; well, $25/oz might look like a pretty decent price for me. Not to necessarily warehouse it, but to get an order in so I've got one more month in my factory, and so on.

The investment side is very similar to gold's. Most people, now that silver is above $20/oz, are looking at silver in a similar manner to how they look at gold: as wealth preservation, as money. All those same, well-worn phrases about the gold market and why people invest in gold are used now in the silver market.

HAI: Have the dynamics of silver demand definitively shifted over the past year or two? After all, industrial usage was once silver's main demand driver, but now investment demand has become such a major force in the market.

Morgan: Well, yes and no. What's really moved the silver market, if you want to trace it to a single point in time, I think it would be April of '06, when [[SLV]] (the iShares Silver Trust) started. There was pent-up demand, primarily from money managers who were restricted from buying commodities by law. But since an ETF is a stock, they're allowed to buy that, even though it is a commodity. It solved their problems.

So you saw this huge amount of investment demand that continues to grow. It's grown at a 14 percent compounded growth rate since April 2006, up until about the last quarter of 2010. Can it continue at that rate? The answer is no. It can't. There's just not that much silver to invest.

HAI: Earlier, you said you thought silver was primed for correction soon. But despite that, do you see prices in 2011 continuing their overall upward trend? Or will this pullback last for a sustained period of time?

Morgan: Right now, my take is that we are going to get a pretty good pullback, particularly in gold. It's easier to analyze than silver. That could be a matter of months - two, three, four maybe. And we'll hit a bottom in there and then we'll start back up.

So my prediction for the year ahead is we're going to see some pain in the silver market. The guys that got in at $30/oz and thought it would go to $40/oz may be disappointed. It may get below $25/oz, it may get down to the 200 moving day average. I don't know. I doubt it would get that low but it could. Wherever it goes, it goes.

Then it's going to build back up from that level, come back up and take out the old highs. So, do I expect it to be higher over 2011 than 2010? Yes. How high? $40/oz. But it's going to take some time to do that.

The problem with making these forecasts is there's always a black swan out there. I'm really not a gloomer, but I am a realist, and there's a lot of black swans out there. If the euro has another big problem that can't be squeezed over by the debt markets coming to their rescue, then all bets are off.

HAI: How is today's rally in silver different than the last one in the 1970s and 1980s?

Morgan: First, it's a global market. Last time it was driven by a very small group of people in the United States. This time, it's a global market that's hedging their bets against the reserved currency of the world, the U.S. dollar. Last time, you couldn't buy silver over in the bank in China. You can now. Russia wasn't investing in the silver market last time, at least for investment purposes. They are now. I mean, basically you can now buy silver and gold worldwide.

The other thing that's so interesting about silver now is that the supply has gone down. When the Hunts ran the price up to $50/oz - and it only traded there for a few days, and I want to be clear about that; but nonetheless, it did trade there - there were 1.5 billion ounces more silver available then today. So now you've got much less silver to invest in.

HAI: So at this point in the silver rally, do you prefer silver equities or the physical space?

Morgan: Oh boy. That's tough.

HAI: I know.

Morgan: When you start out, I think you should start with physical metals. The reason for that is to get familiar with it, which sounds kind of corny. But you're less likely to get scared out of the market when you buy coins or bars.

HAI: Interesting you say that, because many investors approach the space with experience in stocks. And you'd think they might feel more at home with the equity space.

Morgan: That's true. But the problem with equities, especially from the newer folks, is they're only a mouse click away. And you get that, "Oh my God!" feeling. So I would say physical first and then equities.

Equities are undervalued, but part of my analysis for the long term is that the S&P looks pretty toppy here to me. I know there are lots of arguments (in favor of recovery); I know that there's $2 trillion that these larger, better-managed corporations have on the sidelines. But I don't like what I see in the general equity market in the U.S. right now. I think the rally is done temporarily, because of just the momentum and the amount of volume. There's not huge volume coming in anymore.

BEAR: Jim Lowell: Silver's Fear Trade Dissipating; Time To Get Out

HAI: You were big on silver last year. But you sold off all your positions recently. What made you change your mind?

Jim Lowell, editor of Fidelity Investor : Any time anything goes up over 100 percent inside of a 12-month time frame, I ask myself whether it's going to get better or worse ahead.

We put silver into our model portfolios back in March or April of last year with a very bullish call, using the ProShares Ultra Silver ETF [[AGQ]]. Since we purchased it, that position had risen about 178 percent - enough to, in and of itself, trigger some gains-taking.

But back then, I didn't just buy the ProShares Ultra Silver ETF. I paired it with the ProShares Ultra Short Gold [[GLL]] ETF. So what I was really doing was making a bearish call on gold, but saying that I thought I was probably early on that call, and wanted to offset it with a good enough hedge. So that, if I was wrong, I'd be able to still come out ahead.

Net-net, that pairing gave us about a 58 percent return. Gold was up about 26 percent last year. So this year, the sale of silver was triggered by taking gains, but also, I wanted to get out of gold just wholesale. I just wanted to be out of the metal. Because gold, of course, has no real industrial applications the way silver does. You can't build a catalytic converter without silver, for example.

At these levels, you've really got to ask yourself what will propel gold much higher. And, if gold can't go much higher, then silver really can't either, since it trades as a multiple on the fear trade of gold.

HAI: Is that fear still present in the marketplace?

Lowell: Absent the eurozone collapsing, I think that fear is dissipating. The themes and threads of global economic recovery are definitely getting twisted a little bit tighter and stronger, even if they're still uneven, at best.

So my call to get out of silver and to get out of gold reflects the fact that I think the gold trade is done. I think silver as a correlated trade is likely mostly done. There are also better places to put your money that didn't rise 178 percent last year. In particular, I wanted to build up a position in [[RPG]], the Rydex S&P 500 Pure Growth ETF.

My sense is that precisely what has kept individual investors away from the market and loading up on gold for the last 2 1/2 years is what's going to drive them finally back into the market this year; namely, the dissipation of fear. But they're not going to chase the smaller-cap, the higher-risk stocks. They're going to look for battleship balance sheets, liquidity and probably even yield. That definitely favors the mega cap side of the market.

So we got out of gold, out of silver - out of gold chips into blue chips.

HAI: We hear a lot of talk about gold being in a bubble. Is silver getting overheated too?

Lowell: Absolutely. I think those bubbles tend to inflate in a correlated manner. It's very rare that silver trades up sustainably without gold doing likewise. And the inverse is also true. It's very rare that gold starts selling off and silver doesn't follow suit.

In neither metal is there a supply problem. Wherever you are trading a commodity that has had multiple significant run-ups year-over-year, without any supply problems, you've got to really zero in on the psychology of demand. So I think both metals head south sometime this year, I think probably sooner rather than later.

HAI: So is today's high silver price supported at all by the fundamentals?

Lowell: It's very hard to say. I mentioned catalytic converters and we've seen car sales begin to come back. Obviously, you can also argue that gold does have an industrial application inside of the telecom universe, too. And that's fine. And you can continue to argue that.

But it's a harder argument to make stick over time. Really, I just don't think that one can argue that there are fundamentals behind a commodity running up when there's not a supply issue. If there was some sort of constriction, like what we see in the softer commodities - wheat, sugar, cocoa - all these are at high levels, but I'm not bailing on them. Just turn on the news. Look at what's happened to Australia, the fifth-largest producer of cane sugar. And you know that, if that country is under water, well, their sugar crops are under water.

So, there are fundamentals in some parts of the commodity market. Not in silver, not in gold. Copper, you could definitely argue, on the fundamental side. But there are more-diversified, less-risky ways to play that metal. For example, you could own the ETF that just concentrates in Chile, whose major export is copper.

HAI: We've seen a significant rise in the level of investment demand in silver over the past few years. Will investment demand continue to trump other sources of silver demand, like jewelry or industrial use?

Lowell: I just don't see the consumer demand for silver being anywhere even close to the demand for gold. I don't see industrial demand for silver putting enough of a constraint on supply.

When fear bursts - right now, it's sort of a slow leak - but when that bursts, these metals are just going to fall from the sky, silver and gold.

HAI: That'll leave a lot of people who were banking on [[GLD]] and [[SLV]] out in the cold.

Lowell: It absolutely will. And, unfortunately for them, their hedge against the metals play is probably long-term Treasurys, which also are going to fall.

You know, fear does funny things to the way in which you think you have safeguarded yourself. One of the ultra-shorts that we do have in the newsletter model portfolios is the ProShares Ultra Short 20-Year Plus Treasury ETF, [[TBT]]. I think that's an easier and safer bet. Because even absent a rate hike, or any sign of inflation, just a rumor of one or the other can cause problems in that end of the market, as we just saw six weeks ago

So yeah, there are a lot of investors who thought they purchased something that could never go down in value, that was ultra-safe, who are going to be looking at, I think, a 30 percent loss inside of the next 12 months.

HAI: So what's the best way to approach the silver market right now?

Lowell: You could short it. We're not holding a short position in silver inside of our model portfolios; again, because I think there are just better ways to make money with less risk in this year's market. But, if you're a trader, and you're looking for a speculative way to engage in the precious metals market, at this particular moment in time, I would be very focused on the shorts.

HAI: Would silver equities be a better play instead?

Lowell: Certainly one way you could play it is with the mining stocks. Unfortunately, when you look back over sort of rolling time periods, there's a very high degree of correlation between the price of metal and the price of those stocks. So when I'm out prospecting for returns in 2011's market, I've left the silver mine. I've left the gold mine. And I've left the metals. I see green in better hills.

HAI: So is there anything that could make you feel more bullish, and move back into silver?

Lowell: Fear would make me move back in. If I were to take my ultra-short position off of the long-term Treasurys, I'd basically also be throwing in the towel on my current cautiously optimistic belief that we are in slow recovery mode. If something dramatic occurred, derailing that macroeconomic view, I would look to go long Treasury and go long gold and silver.

But, it would be unlikely for me to ever own silver if I didn't also want to have some position in gold. If I was very bullish on fear, I'd be long both. Last year, by going ultra-long silver, I wanted to hedge what I felt was an early call on getting out of the gold trade. But this year, I just don't see any fundamental momentum, technical, or even psychological reason to own either.

See also Short Screen Tool: Zero In on Short Opportunities on seekingalpha.com



The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of The NASDAQ OMX Group, Inc.



This article appears in: Investing , Commodities

Referenced Stocks: AGQ , DBS , DD , DOW , SLV

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