By
Mark
Thomas
:
As the author of
SilverPriceAdvisor.com
, I'm now advocating accumulating a large overweight position in
silver relative to gold. First of all, just like stocks, high-yield
bonds, and most investment asset classes, I think precious metals
peaked in price short term right after the Fed QE3 announcement.
That is why my subscribers and I chose to take profits at the
beginning of the fourth quarter, and reduced our precious metals
ETF model portfolio exposure from the equivalent of 140% invested
down to only 50%. It is also why I was taking profit gains in the
mining stocks at the end of the third quarter. Since I now believe
there is more opportunity in the silver market over the next two
years relative to gold, and my subscribers and I have cash, the
7.4% correction in silver in the last two weeks has been
welcome.
However, there are three very important things that you must
understand about the silver market before purchasing an overweight
position in this commodity:
- The most important thing you need to know about the silver
market is that it will trade with about 300% more volatility than
gold does. This means if gold is up or down 1%, silver will
probably be up or down 3%.
- The total silver market is a fraction of the size of the gold
market in dollar amounts, so the market is less liquid.
Relatively small amounts of money in or out of the market will
produce sharp price swings.
- Because there are only a few large institutions, such as
JPMorgan and HSBC that dominate the market making of silver and
are also the custodians of the large inventories, it is an easily
manipulated market.
So before entering the silver market, you have to be prepared
mentally for the volatility you will be exposed to. If you take a
large position like I'm doing, the swings in your profit and loss
will test the nerves of even the strongest believers in silver. So
only you can decide what overall percentage of your assets you are
comfortable with in regard to volatility and the risk you are
comfortable taking. I'm a very aggressive investor, especially when
I think I have an edge and the odds are in my favor. However, as a
former stock investor, I rarely had ever endured the kind of
volatility that exists in silver.
Normally, these traits would make me avoid this investment, and
especially against putting a larger bet on it. However, in this
case, because over the long-term there is such a great demand vs.
supply situation developing, these same traits are what have
recently and will continue to cause silver to outperform gold
dramatically in the next few years.
Another important thing you need to understand about the silver
market is you won't know what's about to happen ahead of time when
the large players really move the market, and you will have to just
endure it if it goes against you. Therefore, it is essential that
you don't use leveraged ETFs like my subscribers and I did last
quarter, because the volatility will intensify. It is difficult
enough to endure the volatility without using a leveraged
non-physical backed derivative to trade it.
Also, do not trade silver futures, because of the high leverage
and the way the exchange can change your margin requirements
overnight. They can crush you and force you to liquidate at the
worst time. Do not do anything that might force you to sell except
when you intend to. Many speculators found this out the hard way in
2011, when the price of silver approached $50 and the exchange
tripled margin requirements. This is supposed to protect the
exchange and it does, but the real reason was to try to crush the
longs and staunch the losses of exchange members, who had shorted
and were literally losing hundreds of millions of dollars.
There is also a clause in every futures contract that it can be
settled in cash, and not actual physical delivery. So if silver
soared so much it was bankrupting exchange members, they could
declare the market is in "liquidation only" mode like in 1980. This
would shortchange the investors on the right side of the trade. Of
course conveniently, this is never done when average investors are
on the wrong side of the trade, but only when members of the
exchange and large institutions are hemorrhaging cash. Another
thing you want to do when accumulating your silver position,
especially if it is correcting, is be patient and average into your
purchases very, very slowly.
I'm also changing strategy somewhat. Friday, I began buying a
new 10% position in Sprott Physical Silver Trust (
PSLV
). This vehicle trades more like a closed end fund than an ETF
although it is technically neither. It currently trades at a 4.16%
premium to its net asset value, which basically means you pay
$104.16 for only $100 of physical silver, which seems illogical
when in the other ETFs, you pay very close to Net Asset Value.
However, it does have some advantages over the other major ETFs,
like the iShares Silver ETF (
SLV
) and ETF Securities (
SIVR
). The iShares Silver ETF uses JPMorgan as its custodian in New
York, and because JPMorgan is the largest manipulator of the silver
market, I would never invest in this ETF. The ETF Securities
Physical Silver ETF is stored by HSBC in London, which is also a
large market maker in the silver market. I trust the actual
physical backing of SIVR more than SLV, and I like the fact the
silver itself is stored outside the U.S., so I prefer SIVR over
SLV. At the same time, the silver being stored in London troubles
me somewhat. However, since that is where gold and silver has
always primarily been traded, I don't think they would ever do
anything to jeopardize confidence in their market.
By far, I feel the safest place to store your metals holdings is
to physically possess them, and I strongly advocate that. However,
metals are difficult to store safely for your retirement accounts,
and if I trade them more frequently, it is almost impossible. So by
far, I feel Canada is the best place to have your metals stored
when you use exchange traded funds or trusts. It is a country with
a long history of mining and natural resources, and most of the
companies involved in the sector are located there, so it is
probably the safest country from government confiscation. They have
different and easy to invest vehicles for their own and foreign
citizens to own gold and silver, like the Central Gold Trust (
GTU
) and the Central Fund of Canada Limited (
CEF
). These are long-term vehicles with extra precautions, like
storage at mints, and they are even insured.
Going back to the issue of paying a premium of 4.16%, I have
personally purchased PSLV before at a 5% premium and had it go to a
10% premium. So I earned another 5% gain in addition to the
corresponding increase from the rise in the price of silver.
Obviously, the premium or discount can work both ways, and the
premium can go down and you can lose principal, even if silver
prices are flat. The premium or discount basically follows
sentiment. When prices and demand are falling, the premium
declines; and if prices and demand are rising, it usually
increases. There is one other factor that is different with a
closed end fund and PSLV. A closed end fund can't ever issue
additional shares to raise new money, yet PSLV has that right, and
frequently does issue new shares as assets in the fund increase. In
the past, this has crushed the premium from 10-12% to 2-3%. This
always angers the long-term holders, but as long as you understand
the effect, it is usually a temporary issue I can live with.
The link below goes to a chart that shows the historical premium
level at which the fund has traded. This is the main reason I will
accept this extra trouble for investing in PSLV.
http://sprottphysicalbullion.com/sprott-physical-silver-trust/net-asset-value/
You will notice it usually trades at between a 5-10% premium,
but right now it trades at the low end of its historical premium
range. Now past performance is no guarantee of future results,
however, it is a guide and insight to investor psychology in the
recent past. I know the big question you must be asking: If there
are other ETFs that trade at NAV without a premium, why do you and
other investors pay a premium for this one? The main reason is this
is the only ETF that actually allows physical delivery of silver
from the trust. As a small investor, you probably won't meet the
minimum qualifications to invoke this feature. However, for larger
individual and especially institutional investors, this is a very
important security feature.
One of the things you will learn about the silver market is that
the paper silver market (all outstanding futures and derivatives)
is many times larger than the actual physical silver market. That
means if a significant percentage of paper silver investors
demanded actual delivery, the price would rocket higher when the
shorts in the market couldn't fulfill their obligations. That is a
fundamental flaw in the structure of the silver market. As time
goes by and demand increases along with very tight supplies, it
will force silver prices to increase much more than the gold
market. That is also why you need to be concerned if you actually
physically possess your silver, and make sure you are using the
best ETF possible to profit from the huge increase in higher
prices. When you own this silver trust, you know it is physically
backed and can deliver the silver. So if there is a breakdown in
the silver market structure, the premium for this trust would
skyrocket. If the market was caught short of silver, the shorts
could bid PSLV to a much higher premium to meet their
obligations.
Disclosure:
I am long [[PSLV]]. I wrote this article myself, and it expresses
my own opinions. I am not receiving compensation for it. I have no
business relationship with any company whose stock is mentioned in
this article.
See also
Bernanke: Redefining 'Savings' Doesn't Make Savers
Richer
on seekingalpha.com