Time to Look at Silver

I'm not sure I've ever made two trade recommendations in the same week, but you guys should be aware of this opportunity if you're not already. If you're looking for a long term trade with the potential to return a double, triple, or even more over the next year, you need to take a look at silver. Gold is on an absolute tear right now, and people have begun quietly talking about $2,500 an ounce gold in the next two years.

The relationship between gold and silver has always been linked and, as gold prices itself out of practicality, more and more people will be buying into silver. Over the 20th century, gold traded at a pretty steady 40x multiple over silver. In other words, if silver was $5 an ounce, gold was somewhere around $200 an ounce. Today the price of gold is 61 times the price of silver. The spread has to narrow at some point, and all indications are that gold isn't dropping to fill the void. Silver has to go higher.

If only a return to a century's worth of equilibrium happened, silver would have to rise to $31.80 an ounce. It's at $20.80 as we speak. But what if gold does rise to $2,500? Even at today's 61:1 spread, that prices silver at $41 an ounce. At 40:1 we're looking at $62.50 silver.

So how do you play it without getting your ass handed to you in the futures market? Once again, ETFs come to the rescue. The silver ETF (NYSE:SLV) is probably the best way to go. Like GLD, SLV is hitting all time highs. If you want an investment you can make and then forget about for awhile, just buy SLV. If silver goes to $30 an ounce (I predicted that would happen by the end of this year at the beginning of this year. Now that looks a little aggressive, but you never know), you're up almost 50%.

As usual, though, if you're looking for the big score the options are the way to play it. Depending on how far you want to go out, you can set yourself up for a double, triple, or even 5-bagger if silver runs like a big dog on the beach. The January 2012 SLV 20 Calls are selling for around $3.50 apiece right now. If you think the move will happen sooner, you can buy April 2011 SLV 20 Calls for $2.25 right now. Personally, I think you'd do fine with either, but the greater upside exists in the Jan 2012 calls. That's a lot of time for SLV to stretch its legs.

Here's how it makes a difference. Let's assume you have $5,000 to invest and that silver hits $30 an ounce by January 2012. You could take that $5,000 and buy 250 shares of SLV today. When SLV gets to $30, those shares are worth $7,500. That's an excellent return. However, if you took that initial $5,000 investment and bought 15 of the Jan 2012 SLV 20 Calls, they'd be worth at least $15,000 when SLV hit $30 - and a lot more if it happened quickly. (Here's the math: $30 share price - $20 strike price = $10 in the money. $10 x 100 shares per option = $1,000 intrinsic value per option. $1,000 per option x 15 options = $15,000 in intrinsic value + whatever time value remains = YOU'RE FUCKIN' DANCING)

As far as I'm concerned, this is another one of those no-brainers, and that's why I'm sharing it with you. If I can make y'all a little dough in the time we share together, I'm pretty okay with that.

Have a great weekend, guys.

Comments (39)

 
Sep 17, 2010 - 9:45am

I've never invested in Calls, but wouldn't an option expire in three months? How could I extend it to Jan 2012? Dang, n00b question.

I win here, I win there...
 
Sep 17, 2010 - 9:52am

arbitRAGE.:
I've never invested in Calls, but wouldn't an option expire in three months? How could I extend it to Jan 2012? Dang, n00b question.

Options can go for longer than 3 months and do not need to have a 3 month tenor (maturity). In the case of January 2012, you would be looking for an option known as a Leap option. Basically, it is a long term option that expires the January of the given year, so there are Leaps for Jan 2012, Jan 2012, Jan 2014, ect.

"Greed, in all of its forms; greed for life, for money, for love, for knowledge has marked the upward surge of mankind. And greed, you mark my words, will not only save Teldar Paper, but that other malfunctioning corporation called the USA."
 
Sep 17, 2010 - 10:14am

My beef is that the correlation between the two will (continue to) break down as more and more investors start to look at gold as a currency, not as a commodity.

looking for that pick-me-up to power through an all-nighter?
  • 1
 
Sep 17, 2010 - 10:23am

<span><a href=//www.wallstreetoasis.com/finance-dictionary/what-is-london-interbank-offer-rate-libor>LIBOR</a></span>:
My beef is that the correlation between the two will (continue to) break down as more and more investors start to look at gold as a currency, not as a commodity.

That's actually what I meant about gold pricing itself out of practicality. Eventually, gold will be so expensive that people will no longer view it as money, and will look to silver as an affordable and practical substitute. When we're talking about tangibles, it sure feels like you have a lot more of something valuable when you're holding 61 ounces vs. 1 ounce.

 
Sep 17, 2010 - 12:20pm

Edmundo Braverman:
<span><a href=//www.wallstreetoasis.com/finance-dictionary/what-is-london-interbank-offer-rate-libor>LIBOR</a></span>:
My beef is that the correlation between the two will (continue to) break down as more and more investors start to look at gold as a currency, not as a commodity.

That's actually what I meant about gold pricing itself out of practicality. Eventually, gold will be so expensive that people will no longer view it as money, and will look to silver as an affordable and practical substitute. When we're talking about tangibles, it sure feels like you have a lot more of something valuable when you're holding 61 ounces vs. 1 ounce.

Interesting. I guess it makes sense that Silver could be a currency just like gold. However, doesn't silver have a lot more industrial applications than gold, making it more difficult to be a currency instead of a commodity (I don't follow Silver markets closely but I do follow gold). Wouldn't the industrial end users also effect the supply/demand fundamentals, whereas with gold the market participants are mainly investors, central banks, and producers? (not trying to challenge you I'm just eager to learn)

looking for that pick-me-up to power through an all-nighter?
 
Sep 17, 2010 - 2:04pm

Edmundo Braverman:
<span><a href=//www.wallstreetoasis.com/finance-dictionary/what-is-london-interbank-offer-rate-libor>LIBOR</a></span>:
My beef is that the correlation between the two will (continue to) break down as more and more investors start to look at gold as a currency, not as a commodity.

That's actually what I meant about gold pricing itself out of practicality. Eventually, gold will be so expensive that people will no longer view it as money, and will look to silver as an affordable and practical substitute. When we're talking about tangibles, it sure feels like you have a lot more of something valuable when you're holding 61 ounces vs. 1 ounce.

Funny you mention that because my father, being old school, has been 'collecting' silver coins over the least year or so as a hedge against inflation. When he was younger he collected coins/stamps as a hobby and eventually got out of it, but, as the economy started taking a turn, he resurrected the hobby and has filled up a safe and a few safety deposit boxes with all the silver coins he has purchased. Maybe him taking them off the market has inflated the price, lol.

At any rate, his intent is to try and hedge against what he feels is unavoidable inflation while maintaining something that he feels will have value regardless of what occurs. The thought is the coins will always have a value because (1) they are made of silver so as long as the trading price is up they are worth something extra and (2) they are mostly rare, collectible coins, which will likely hold their value long term as they become more rare. Time will tell if the old man has played it right or if he's being paranoid.

I will pass this post along to him and see if he wishes to dabble in the market at all. Thanks Edmundo.

Regards

"The trouble with our liberal friends is not that they're ignorant, it's just that they know so much that isn't so." - Ronald Reagan
 
Sep 17, 2010 - 10:41am

I made this call more than a year ago. Silver has much higher vol than gold, though, so you need to know what you're getting into. I wouldn't be surprised to see another ETF or two springing up as a result of this. And if that happens, I will be buying more silver. Why? Commodity ETFs have to 'ring fence' the commodities in which they deal, so each time a commodity ETF starts up, the commodity in question gets bid up relentlessly (in the physical market).

I like platinum more than silver, though. And I really like the non-market traded precious metals. The only precious metals with any sort of liquidity are gold, silver, platinum and palladium. Technically, rhodium and iridium are also precious metals, but those markets are entirely broker-driven. I like things like molybdenum and uranium. Why? Specifically because noobs can't play around in it, and therefore can't distort the market too far from fair value. But when those metals do become more accessible to the public, you can be sure I'll be long.

 
Sep 17, 2010 - 1:04pm

Palladium is replacing Platinum in cat's and is really being driven by Chinese and Indian auto demand. To a lesser extent Palladium is used in jewelry, solar panels, electric vehicle car batteries, etc.

SWC is one of the largest US manufacturers of Palladium. Their mine in Montana also pumps out primarily Palladium as opposed to other mines which produce other PGM's and Palladium is one of them. They just acquired another mine recently.

http://finviz.com/quote.ashx?t=swc

I think 18 is a ceiling for them. If they break that who knows.

 
Sep 17, 2010 - 1:24pm

Anthony .:
Palladium is replacing Platinum in cat's and is really being driven by Chinese and Indian auto demand. To a lesser extent Palladium is used in jewelry, solar panels, electric vehicle car batteries, etc.

SWC is one of the largest US manufacturers of Palladium. Their mine in Montana also pumps out primarily Palladium as opposed to other mines which produce other PGM's and Palladium is one of them. They just acquired another mine recently.

http://finviz.com/quote.ashx?t=swc

I think 18 is a ceiling for them. If they break that who knows.

Thanks for this info. I guess even electric vehicle production won't slow down Palladium, since it can be used in EV batteries.

looking for that pick-me-up to power through an all-nighter?
 
Sep 17, 2010 - 1:18pm

Osmium fools.

Two problems Ed.

1) Silver is so abundant that the "exclusivity" factor present with gold, platinum, etc is no longer present.

2) Since the Hunt situation, silver is always going to be on the watch list...in fact there's plenty of evidence to suggest it's been artificially held down by the CFTC.

Just look at onions, man...STILL NOT A COMMODITY.

 
Sep 17, 2010 - 1:19pm

http://en.wikipedia.org/wiki/Palladium

I LOVE Palladium. I also love silver. Never been a huge fan of gold. All of my jewelry is silver and all of my watches are stainless. I think the color looks so much better.

I think EV have a long way to go. This country boggles my mind though. Batteries are pretty corrosive and pollutive. The energy they require also comes from mainly coal fired plants. Instead of pushing mass transit, increased efficiency, hybrids, ethanol (not corn based), CNG, etc they are pushing batteries.

 
Sep 17, 2010 - 1:48pm

Anthony .:
I think EV have a long way to go. This country boggles my mind though. Batteries are pretty corrosive and pollutive. The energy they require also comes from mainly coal fired plants. Instead of pushing mass transit, increased efficiency, hybrids, ethanol (not corn based), CNG, etc they are pushing batteries.

My thoughts exactly. I remember seeing a report about the carbon output that is produced from making an EV vs a normal car and the EV was actually more than the standard vehicle. Now, I don't know the source of the article or the validity, but it makes you stop and think...and I have heard other anecdotal things since that look to support the previous statement.

Regards

"The trouble with our liberal friends is not that they're ignorant, it's just that they know so much that isn't so." - Ronald Reagan
 
Sep 17, 2010 - 1:56pm

Lets not forget the impact of tech firms using precious metals for development and high yield circuits. This portion of the market just keeps growing as chips get smaller and the need for non corrosive conductors skyrockets. Even if the scare factor of the dollar doesn't drive up the price of gold, simple demand from industry will certainly have a significant effect. The exponential gold price rise started before the economy tanked, evidence of this growing demand.

 
Sep 17, 2010 - 2:17pm

If you look at the very long-term picture, silver was the preferred currency long before gold. The move to the gold standard was largely accidental. While silver is exponentially more plentiful than when we last were on the gold standard, the growth in the money supply can't be too far off. I wish I could find a chart somewhere for that, but in any case I think there still is a case to be made for silver being a store of value in the way gold is. However if gold takes off, I wouldn't be surprised if silver falls to 1/70-1/80 the price of gold. While the smart money is starting to talk about silver, the major players are still largely concerned with gold.

 
Sep 17, 2010 - 2:19pm

cphbravo,

Before my dad died, he told me that he left me something in his toolbox in the garage. I didn't think much about it at the time (we were both mechanics, so I figured it was an impact wrench or something). When he died a couple months later and I was taking care of his stuff, I found 20 years worth of Kennedy half-dollars he'd been collecting - a lot of them from 1964 when they were 90% silver.

The older generation (who were used to dollars being backed up by silver in their younger days) never lost their desire for tangible currency. My boys will be glad to get the Kennedys when I check out.

 
Sep 17, 2010 - 5:29pm

By your logic wouldn't silver only increase if Gold is going to keep its value at 2500. While Gold might hit 2500, I doubt that it will stay there for a long period of time.

Couldn't we view the gold silver price ratio of 41:1 as evidence that gold is over priced, and that gold's is a bubble, and its eventual value will be around 820 (20*41)? What are your reasons for believing that gold will hold its value?

I know someone is going to come back with inflation, but I do not see reasons to statistical reasons to believe that we will have inflation that will keep gold at as much as 1500. Furthermore I do not see evidence that inflation is particularly high (compared to the norm).

This year's inflation is at 1.8 right now. Last year we had deflation at .4%. Our median inflation for the decade is 2.65% with a max of 3.8% in 2008. And from glancing at the data, I would guess that we are trending toward lower inflation. The median of the decade before is 2.7, with a max of 5.4%, and by glancing at the data the mean from 1990-2000 is greater then this present decade. For the 80s the median is 4.2% the high is 13.4%. The 70s have a median of 5.75% and a high of 11.0%. This data might be off by a couple of tenths of percents, because I eyeballed it, as i couldnt get excel to paste my chart. If I did, I would have subjected you to a little more noob analysis.

The point is that that there was a period between the 70s and the 80s that gold kicked alot of ass. The inflation in those years was often double digit, and it was not followed by any deflation. Once inflation was brought under control gold came back down. Furthermore, part of the reason gold rose so dramatically in the early 70s was that gold prices were kept artificially low (till 71), as our currency was pegged to it.

Right now we have lower inflation then we did in the 90s, which was a decade of gold stagnation. The point is that I do not see a correlation between the levels of inflation that we are at and the rise in gold prices.

If any of you could tell me why my above analysis is wrong, or ignores pertinent facts I would appreciate it.

All this being said, I believe that gold is a great opportunity for someone that wants to trade, but I think it is a bad long term investment. However, I would buy and hold silver at 18, based on the gold silver ratio. As caveat, when I invest I am much more conservatively minded then most of you probably are.

 
Sep 17, 2010 - 6:06pm

While I don't do work with commodities (semiconductors...yay), don't commodity ETF returns and spot price trends have some really huge spreads due to contango and set trading times? What usually happens when the spot price explodes over the short run with ETFs?

"Dude, not trying to be a dick here, but your shop looks like a frontrunner for the cover of Better Boilerrooms & Chophouses or Bucketshop Quarterly." -Uncle Eddie
 
Dec 6, 2010 - 11:21am

I really wasn't sure it was going to make $30 an ounce by year end, but here we are. The January 2012 $20 calls are now up a triple, so by all means sell half the position if you haven't already.

I think silver goes a lot higher actually, but you can never go broke taking a profit.

 
Dec 8, 2010 - 10:03pm

Edmundo Braverman:
I really wasn't sure it was going to make $30 an ounce by year end, but here we are. The January 2012 $20 calls are now up a triple, so by all means sell half the position if you haven't already.

I think silver goes a lot higher actually, but you can never go broke taking a profit.

Wish I hadn't closed my jan 2011 calls in November.

I win here, I win there...
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