Get Ready for Stupid Cheap Silver Prices
Source: Brian Sylvester of The Gold Report
It's a jungle out in the silver markets. Investors are holding on for their lives as the price of metals swings to higher highs and lower lows and junior equities bounce along the bottom. In this interview with The Gold Report, David H. Smith, senior analyst at silver-investor.com's The Morgan Report, navigates the jungle by advising buying on the way down and selling on the inevitable way up.
The Gold Report: David, Silver Investor analyzes the long-term macro trends and specific stock catalysts in the silver market. What do you see as the risk/reward profile over the next 12 to 36 months in the space?
David Smith: A lot of people, including myself, are looking for a bottom. It may be in—or it may not be in. The secret is to focus on the upside, which could be 10 or 15 times higher, rather than asking if it could be two or three dollars lower. That makes it easier to buy at these prices.
TGR: How long could this slump last?
DS: Mining stocks have been disconnected from the metals prices for almost two years. We had major tops in gold and silver, but the mining stocks, almost across the board, regardless of quality, have gone down, down, down. The disconnect is greater than two standard deviations away from the norm. That sort of thing can last a while, but it doesn't happen very often. In fact, there's a 97% probability that it wouldn't happen or that it wouldn't stay there if it did. I think that we are nearing the end. We could see this weakness go into the late summer/early fall, but I think we are building an important base even if we go lower. The stronger that base gets and the broader it becomes, the more likely it will move violently on the upside. If you have no position waiting for this, you will be left behind.
TGR: How do investors survive the horrendous swings going on in the meantime?
DS: Volatility can be a good thing if you are prepared for it. The secret is to not wait for those swings to occur and try to predict them because you'll be jumping on what Jsmineset's Jim Sinclair calls a rhino horn and you'll get speared. If you're able to do the opposite of what most people do, to buy weakness and then sell a little bit into strength, you can smooth out the big swings. I believe that we'll see swings of $100–200/ounce ($100–200/oz) a day in gold when this thing finally moves into the public mania phase. It would not surprise me to see $5–10/oz swings in the price of silver in one day. We saw this during the bull market that ended in 1980 and I think the price increases are going to be much greater this time around. If you have layered your positions, your mining stocks, your exchange-traded funds (ETFs), your physical purchases into weakness, when the swings happen you won't be affected as much as most of the public.
TGR: Would you like to make any predictions about the silver prices over the next 10 years?
DS: This is always very difficult. Economic conditions are a major variable because, as you know, about 70% of the supply of silver comes from byproduct production of copper, lead and zinc. The global economy will affect how much of that is dug out of the ground. Relatively few silver miners receive most of their income from silver as opposed to base metal credits.
TGR: We often hear how silver is like gold's little brother. Other than silver having an industrial demand profile, how are these metals different as investments?
DS: Almost all of the gold that has ever been produced is still out there in some form: in central banks, in private holdings, or in jewelry. A certain amount is used in medical or industrial applications, but not on the scale of silver. When silver is used in radio frequency identification (RFID) chips or electronics, it is gone and must be replaced.
Another increasingly important factor is the emerging popularity of ETFs. Like gold, silver has been real money for people going back thousands of years. It has outlasted every paper system ever developed by humankind. It's going to outlast the current ones as well, because it preserves purchasing power as paper money loses it.
TGR: Does owning silver equities, particularly small-cap equities, still make sense in this market?
DS: Equities make sense more than ever before because of the disconnect between the price of metals and what the companies can dig out of the ground. The entire mining sector, whether it's a large producer or an explorer, is high risk. But after buying the physical metal, it makes sense to pick up the equities at all stages. Buy a few of the majors, then go into the midtier section and finally the explorers, which are the highest risk because they may or may not ever go into production. Put a small amount of capital in and allocate it roughly proportionately so that if one choice blows up, the others will make enough that you will still make a profit. Owning equities is very important, but be selective. Scale down any purchases into this historic decline.
TGR: Before we started our interview, you talked about the concept of keeping some money back for what you called stupid cheap prices. Tell us more about that strategy.
DS: I think Doug Casey used this term first, but it was certainly correct. Prices are now lower than what most people thought they would ever sink. I learned something very important in the 2008–2009 meltdown. I started out with about 30% cash at the top. Prices kept dropping as part of what nearly became global financial destruction. I bought quality mining companies down, down, down. Then I ran out of money before the end. I had good quality companies I had bought at pretty low prices, but I didn't keep back a little bit for what Doug Casey calls stupid cheap prices.
That was when I learned to buy larger price differences. In other words, instead of buying every dollar on a company, I might buy every $4 down and keep a little bit back just in case the price went even lower. It was likely to be temporary because it was similar to a rubber band being stretched almost to the breaking point. If you had the courage, the money and the foresight to buy at that point, when that rubber band snapped back, you could make a great deal of money with very little commitment.
Those concepts are as important today as they were in 2008. We may or may not be at the bottom now. There are indications that the mining stocks are bottoming. Some of them may have already, but if we get one more washout, which is possible this summer, and if you have a little bit of money left, you may be able to pick up a company that today is selling for $2/share, for $0.75 or $0.50/share. You will already have your core position, but you will be buying down into that lower level.
Dollar cost averaging is one of the most powerful tools an investor can use. If you're buying in tranches on the way down, you're almost rooting for lower prices because you're going to lower your cost of having that position. There is a saying that when the price goes up you never have enough shares and when it goes down you never have few enough shares. The reality is that you get your initial position in and then you can be calm and watch for lower prices.
TGR: What do you make of the recent strategy in which large companies take bite-sized pieces of a number of smaller companies in an effort to get an inside view perhaps of what's going on in these companies?
DS: That's a very viable strategy. A number of companies are doing this right now. Taking a 19% position of an exploration company with an exciting project could give exposure to some big upsides. If they hit well that will be nice. If they don't, they're not going to be out a lot of money. It also gives a lifeline to these exploration companies that might otherwise not make it because of the tremendously difficult financing environment.
Large companies are realizing that they have a responsibility to help good exploration companies keep the doors open. If all these companies blow away, the feeder stream that nourishes the large mining companies is going to dry up. It's like the food chain. If all the baitfish in the Atlantic were gone, the big fish would die because they are dependent on that food chain. Eventually it would be a disaster.
TGR: You have written about ETFs lately. Do you think that they've killed mutual funds or trusts?
DS: I think ETFs can be an important part of a portfolio depending on the investor. They can be used as a management tool. Obviously you can't redeem them for the metal and some people don't like it because of thatl. David Morgan has suggested the use of ETFs as a way to hedge at times in his videos to members, as a way to trade. The ETFs based on baskets of mining stocks can also lower equity risk by diversifying the portfolio.
Not all ETFs are well run. Some of them don't perform as advertised. But they give investors more flexibility than mutual funds. You can only buy and sell mutual funds at the end of the market day but you can buy or sell an ETF just like a regular stock at any time. Some ETFs don't have a lot of volume, but most of them do. It wouldn't surprise me if the time comes when the mutual fund industry is just a shell of what it is today because the ETFs are providing a tremendous alternative for large and small investors.
TGR: The tag line on silver-investor.com is "Buy Real. Get Real. Be Real." How are you staying real?
DS: I love that quote. You buy real by buying the physical metal. You start with that. You get real by looking at yourself in the mirror and understanding that the market doesn't know you, it doesn't have anything against you, but you need to know the rules if you're going to persevere and survive. You stay real by keeping things in perspective. It isn't just about making money. It's about doing the right thing, treating people properly, being straightforward and being a lifetime learner.
TGR: Thanks for your insights, David.
David H. Smith is senior analyst for The Morgan Report, as well as a professional writer and communications consultant through his business, The Write Doctor Inc. He is a regular on HoweStreet.com. Smith has visited and written about properties in Argentina, Chile, Mexico, China, Canada and the U.S. He is an investment conference/workshop presenter at gatherings in Canada and the U.S. His work for subscribers can be found on Silver-Investor and for the general public at Silver Guru.
1) Brian Sylvester conducted this interview for The Gold Report and provides services to The Gold Report as an independent contractor.
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