Score one for the bulls. When I recommendedshares of
Couer D'Alene Mines Corp. (NYSE:
n late January
, there was a raging debate about whether silver prices would rally
to new highs or finally come back to earth. I thought the bulls had
a stronger case, and Couer D' Alene was a solid play on any silver
rally. The shiny metal has risen in price from $28 to $41 andshares
of Coeur D' Alene have come along for the ride, surging more than
60% in just six weeks.
Yet for a host of reasons, some or all of those gains may be lost
in coming weeks and months. It's time to take profits and even
think about establishing a short position in this highflying name.
A bubble in the making?
To understand why silver has rallied so quickly, you need to
understand the psychology behind investor sentiment. Silver's 80%
gain in the past year has made it a darling of theinflation hawk
crowd (as gold had been in prior years). Demand for silver to be
held purely for investment purposes has increased 40% in that time.
Trouble is, the more appealing silver becomes as an
, the less appealing it becomes in the real world, where it is used
in a wide range of industrial applications.
As silver becomes more costly, the "substitution effect" occurs
whereby other less expensive metals get swapped in and replace
silver in industrial uses. We're already seeing signs of demand for
silver start to cool among industrial buyers.
Meanwhile, the high price of silver is leading to what always
happens when acommodity surges in price: increased mining activity
that boosts supply. Analysts at UBS estimate that recently
initiated mining plans should push global production of silver up
by 25% in the next four years.
Barrick Gold (NYSE:
, a pair of yellow metal plays, actually have the most ambitious
silver mining expansion plans. (Most of the world's silver is
produced from non-silver mines; i.e. from lead/zinc, copper and
gold mines as a by-product.)
UBS estimates supply will stay just ahead of demand, as this chart
shows. Yet it's important to know these assumptions were derived in
late February when silver fetched $32 an ounce. In fact, UBS'
demand estimates assume that silver will end the year at $33 and
then steadily slide in price to less than $20 by 2014. Instead,
silver has pushed past the $40 mark and, before long, you could
start to see industrial demand being affected. (Supply is likely to
continue to grow as miners need to complete projects once they're
underway and can't simply close a mine as end-market prices start
Industrial demand averaged 800-850 million ounces from 2004 to
2008, slumped badly in 2009 and rebounded to a record 915 million
ounces in 2010. Yet expectations that demand will keep rising now
look much riskier. As traditional drivers of demand such as
photography and dentistry start to use alternate materials, then
demand is likely to flatten rather than rise, even if the
globaleconomy keeps growing. Any rising gap between supply and
demand would surely blunt silver's price momentum.
Gold vs. silver
As gold and silver are both used as hedges against inflation, it's
helpful to see how the two metals compare to historical levels.
From 1978 to 2008, an ounce of gold bought about 60 ounces of
silver. Thanks to silver's strong surge, that ratio has shrunk to
36. To return to historical levels, gold would need to rise 75% to
around $2,500 an ounce or silver would need to drop from a current
$41 to $25, or about 39%. Unless inflation spirals out of control
(which still seems unlikely as of now), gold is unlikely to rise
that high, so the logical conclusion is that silver must fall to
return back to that historical ratio.
Production ramping, then peaking
Couer D' Alene has benefited from rising silver prices and the nice
in production at a major mine known as Palmarejo. Output could rise
even more this year, but then start to fall in subsequent years as
some of Couer D'Alene's other mines start to produce less and less.
That's why UBS expects revenue to drop 16% in 2012 to $808 million
and another 15% in 2013 to $683 million. EBITDA (earnings before
) is likely to peak at around $600 million this year, but slump to
$300 million by 2013, according to UBS. Again, that forecast
assumes rising industrial demand that undergirds silver prices,
though it's unclear if that will really pan out.
Action to Take -->
As inflation concerns persist, investors have shifted their sights
toward silver. Yet the speculative end of the market is creating
real pressure on the industrial end of the market. For Couer D'
Alene, it's been a perfect alignment of positive factors. With
silver now looking very pricey in relation to gold and in relation
to other industrial metals, the coming quarters are likely to be
far less supportive for this stock. A move back to $30 appears in
the cards once the frothy silver market starts to cool. So if
you've mad money on this trade, now appears the time to get
-- David Sterman
P.S. -- I don't know if you're aware of this or not, but a
20-year energy agreement between the United States and Russia is
about to expire. The problem is, this deal supplies 10% of
America's electricity. When the Russians refuse to renew the
agreement, the U.S. will face an entirely new kind of energy
crisis. This disruption could send a handful of energy stocks
through the roof. Keep reading…
Disclosure: Neither David Sterman nor StreetAuthority, LLC hold
positions in any securities mentioned in this article.