Silver’s “Historic Price Glitch” — will it jump to $208 in six months?

Sniffing out Sara Nunnally's "Silver Fever" tease for Macro Trader

By Travis Johnson, Stock Gumshoe, November 20, 2012

I’ve had quite a few readers write in to ask me about silver lately — there was a spurt of “silver will be better than gold” newsletter teasers over the Summer, and this latest pitch from the Insiders Strategy Group folks for their Macro Trader newsletter has been filling up the inbox …

… so let’s have a look and see what Sara Nunnally says we should do to invest in the shiny stuff.

And just up front, I should also let you know that I don’t follow silver slavishly, so I’ll tell you what I can but I don’t follow the conspiracies or the silver production numbers every day.

Here’s the hook that they use to get you on the line:

“Why This Historic “Price Glitch” Could Force Silver to Jump From $33.50 to $208 in the Next Six Months…

“Did BIG BANK CHEATING Create This Glitch?

“Here’s How You Can Take Advantage of It Today.”

Which pretty well sums up the big picture argument they’re making for silver having a big run — the “price glitch” is a reference to the fact that the silver/gold ratio is out of wack and a return to the “average” would mean a huge silver spike (or a huge fall in the gold price, naturally); and the “big bank cheating” stuff is a reference to the manipulation of the silver futures markets by JP Morgan and others.

The silver manipulation conspiracies basically revolve around a few large banks dominating the futures markets in silver, and holding huge short positions which they use their trading to buttress, trying to keep prices down whenever they show signs of taking off. I don’t know or care much about the mechanics of this, but there have been plenty of very detailed articles about it and plenty of things to make the conspiracy story seem like it’s ripe for a TV movie — including the (loose) connection to the downfall of Bear Stearns, and the fact that the prime whistleblower in this case was injured by a hit and run driver just as his testimony was getting attention. There was a good blog post at the NY Times on the whole conspiracy/price manipulation foofaraw last year, it’s dated now but he explains it all much better than I can so you can check that out if you don’t know the basic story.

I know many people feel strongly about this silver manipulation story — I’ll leave it to you to go read up on it and decide what you think. Certainly silver has been manipulated before, most famously when the Hunt brothers tried to corner the silver market (which in turn led to some of the futures trading position/leverage limits) about 30 years ago, back when silver had its all time nominal peak near $50 an ounce … whether it’s being actively manipulated now, the nature of that manipulation, and whether that manipulation will stop, is an open question.

The other part of the argument put forth here for silver is that the manipulation has kept the lid on a per-ounce price that should be dramatically higher because of the gold/silver ratio. Here’s a longer excerpt from the ad explaining (or selling, at least) that basic point:

“The value of silver throughout history has been tied directly to gold.

“As far back as the Roman Empire, the value of silver was set at 12 ounces for every ounce of gold.

“And when the U.S. fixed its own gold standard in 1792, that ratio was set at 15 to 1.

“Silver is often referred to as “poor man’s gold” for that reason.

“You see, it has intrinsic value like any other precious metal. That’s what makes it a reliable store of wealth…

“But you can get it at a fraction of the cost of gold.

“That means it’s much easier to build a position in silver without having to come up with $1,730 or more just to buy a single ounce of gold.

“Part of the reason it’s so much easier to get into silver is the silver glitch I talked about earlier.

“The silver glitch is pushing the price of silver down way below where it belongs.

“Silver should track gold’s performance… for example, let’s use the Roman standard of 12-to-1…

“At $1,730 per ounce of gold, history tells us that we should be seeing silver prices at $144 per ounce.

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“But today, the historic silver/gold ratio is wildly out of control.

“The gold market has rocketed to historic highs in the past 10 years, but silver hasn’t risen at the same pace.

“That’s the glitch I’m talking about. Silver is wildly underpriced on a historic basis.

“Currently, you would need 52-53 ounces of silver to buy just one ounce of gold.

“That’s because the big bank market manipulation buries the price of silver… and stops it from reaching the natural historic 12-to-1 ratio.

“Now, with the CFTC breathing down their necks, JP Morgan and HSBC won’t be able to blatantly control the silver market.

“And without any interference, the silver glitch could move quickly to correct… driving the price of silver all the way up to its historic 12-to-1 ratio with gold…”

The gold/silver ratio is not magic — the ratio of gold reserves to silver reserves is probably in the neighborhood of 10:1, and the ratio of gold to silver in the earth’s crust has been estimated at 20:1, so the number of something like 12 or 15 makes some intuitive sense and helps to bolster the argument … but as with anything else, it’s not just the supply that determines the price. It’s the demand.

Gold has fluctuated over the years as jewelry demand has waxed and waned, but in the last decade or two it’s been almost entirely a “store of value” play as folks look for something to hold value during inflation or currency manipulation. Silver has become a “store of value” play more recently, too, with investors looking to get in on something that’s cheaper and easier to acquire in small quantities, but it is also an industrial metal that is consumed in massive quantities, so industrial demand has driven the price through some big fluctuations — particularly with the abrupt demise of film photography, a major silver use. Still, you can probably argue that silver should be more valuable than gold — it gets used up, it’s an important industrial metal (for lots of reasons — antibacterial qualities, highly reflective, highly conductive and non-resistive — silver is in tiny quantities in millions of products), and it is just as shiny. Still, human culture puts gold at the top of the list — you don’t see Indian brides collecting trunks of heavy silver necklaces, or nervous young men getting down on one knee in unaffordable New York restaurants with silver rings in pale blue boxes.

So the short answer from me is: I have no idea where the gold/silver ratio might head, but the craziness of the chart during the post-industrial era and the “fiat currency” era doesn’t indicate to me that there’s any “stickiness” of any particular magical ratio in the prices of these two metals in modern society. I’ll borrow a couple versions of the gold/silver ratio chart here so you can see what I mean:

So what is one to do? Beats me. I own some physical silver and some exposure to silver through ETFs and the like, but not because I think that we’re going to see the gold/silver ratio return to Roman or even 19th century levels. The average for the last 40 years or so, since we officially lost the “silver standard” for US currency, has been a gold/silver ratio of something in the neighborhood of 50 … but we also had perhaps 20-25 years or so in there when silver did almost nothing at all, when the big moves in the gold/silver ratio were largely due to changes in the price of gold, before the last decade when both gold and silver have made tremendous runs. I actually think silver will do pretty well over the long run as industrial demand continues to emerge and the fiat currencies of the major financial powers continue to depreciate, but it’s just part of the “hard assets” part of my portfolio that includes some gold, some silver, some mining-related stocks and some other “real” stuff like real estate or other hard-to-replace assets that should hold value despite long-term currency weakness. I do not think that we’ll return to a real silver standard or a gold standard on either a US or international level, where currency is again backed with precious metals … but if we do then all bets are off — and perhaps in a bad way relative to purchasing power, if government sets the value of something it rarely sets it just where you’d like it to be.

But that’s not the real point of the teaser ad, as you’ve probably guessed by now — we’ve seen people predicting outsize gains for silver for many years now, and though the silver price targets fluctuate depending on what measure they use ($134! $208! $155! $62!), they all, of course, promise not only that silver is going to go up, and dramatically so, but that they have the best secret way to invest in silver that you haven’t thought of yet.

And Nunnally is no different. She’s looking at $208 silver when the “price glitch” of the last 100 years corrects … and she’s got some special ways for you to invest to profit from that correction. So even if we consider it a bit absurd that silver might “correct” to $144 “within days” we might still be interested in her silver ideas (we’re glossing over some of her argument, you can see the whole ad here if you want) … so what are they? Here’s how she puts it:

“Will You Be Ready When the Price Glitch Corrects and Silver Shoots Toward $208?

“Today, you can get in on the ground floor of a historic move in silver prices that could hand you huge gains.

“This move has nothing to do with coins or bars of silver.

“It doesn’t involve old-school silver miners. It’s not about groveling for ‘junk silver’ at your local bank.”

That last bit is a nice little elbow in the ribs for Dr. David Eifrig and his two coin silver pitches, the half-dollar-focused “five magic words to say to your bank” pitch and the long-running junk silver “buy silver for under $3” pitch. So what is she talking about as a way to play silver?

Well, the first one is some kind of fund … here’s how she teases it:

“I’m happy to report I’ve discovered an opportunity that makes it easy to own physical silver.

“The silver you own is stored for you in a secure vault where it stays safe until you decide to cash in on a big market swing.

“This special vault is not owned by a bank… so there is no danger to your silver from bank failures or government appropriation.

“As you may have already guessed, it’s an exchange traded fund (ETF).

“No, I’m not talking about the hugely popular silver ETF trading under the symbol ‘SLV.’

“This is a special ETF. As you’ll see, it’s far better than SLV.

“This special ETF gives you a way to buy safely stored silver bullion… and you can do it right on the stock exchange.

“Better yet, if you choose… your shares of this ETF can actually be cashed in for bullion.

“That’s right, real physical silver available to you on demand.

“And because of a special designation this fund carries, you could even qualify for a lower tax rate on your gains when you decide to cash in!”

There are a couple of silver-backed exchange traded funds, but I think with this one they’re teasing the Sprott Physical Silver Trust (PSLV in NY, PHS in Canada). This is actually a closed-end fund (meaning they have to have follow-on offerings to create more shares, they don’t just create new shares as they’re needed), but it’s quite liquid and is an investor favorite. The shares are technically redeemable on a monthly basis, though you have to redeem a minimum of 10 “London good delivery” bars, which in practice means the minimum redemption is somewhere in the neighborhood of $250,000. So it’s real, and it should provide a base for the share price if they ever traded at a substantial discount to the silver net asset value in the fund, since institutions could redeem and close that discount … but PSLV hasn’t traded at a discount and has usually, in fact, traded at a pretty stiff premium to their net asset value. Which would make it foolish to redeem the shares (“Excuse me, can I please have $12 of silver in exchange for my $13 shares? Yes, charge me the redemption and shipping fees too, please!”).

Interestingly, PSLV has finally closed the massive premium gap to a large degree — for most of last year some folks were paying absurd premiums of 10 or 20% just to get shares of this fund, even more than you’d pay to buy Silver Eagle coins and have them stored for you, and over the winter that premium even spiked to 30%+ for a few weeks, but it has steadily dropped this year and the premium is now down to less than 2%. You can see the historical premium/discount chart and the current calculation here.

And yes, if we assume that there will continue to be a discounted tax rate for capital gains next year, then US shareholders might be able to get that discounted rate (currently 15%) instead of paying the higher capital gains tax that’s generally due on collectibles. Most ETFs, like the big gold (GLD) or silver (SLV) funds, warn that investors will be subject to the higher 28% collectibles rate, but since PSLV is classified as a passive foreign investment company you apparently can, with a bit of work, get the lower rate. You can read about that on PSLV’s website here, and for God’s sake don’t rely on me for any kind of tax opinion or advice.

So that’s the exchange-traded fund option from Nunnally, I expect. What else is she touting?

“Did you know that there’s a way to profit from silver mining, without ever owning a single mine?

“Let me explain…

“I’ve found a way you can profit from what’s called “silver streaming.”

“Silver streaming happens when a company pays a premium to a miner and then has the option to buy all of the miner’s silver production at a low fixed price in the future.

“The miner gets some capital upfront. It can use this money to expand operations, acquire new assets or just guarantee more time to bring its find to the market.

“The silver streaming company gets cheap silver they can turn around and sell at market prices, sometimes booking big profits.

“Having sources of silver that won’t be affected by market changes helps them to have a more stable flow of income, as well….

“What makes this play truly unique is that this top performer has made deals with massive mines that produce silver as a byproduct of other mining efforts.

“Essentially, the miners get silver when they’re looking for other metals like gold, copper and zinc. It wasn’t their intention to be silver miners.

“Silver’s just an added benefit to their main mining concerns.

“So they’re happy to sell the rights to it upfront and get more cash to build their mines.

“And because this silver streaming company is paying upfront, it can buy the silver at a tiny fraction of the market price.

“The best part is, this is a long-term deal… the price the silver streaming company pays for the silver isn’t going to change.”

Well, that’s quite clearly referring to the world’s largest streaming/royalty company, Silver Wheaton (SLW). Which is also the only one of the major royalty/streaming companies that’s looking relatively inexpensive if you look at their current financials (the gold-focused ones are substantially more expensive on a PE or cash flow basis), and arguably trades at a discount to their expected growth rate. But I’ve written about Silver Wheaton many, many times so if you want more details on that you can check out my most recent piece, when I unearthed them as the solution to Matt Badiali’s “Canadian Silver” teaser. I would buy SLW before I bought any silver miner, but I don’t own shares now.

And our last tip from Nunnally?

“I also want you to know about a company that’s set to become one of the largest silver miners in the world.

“It estimates its 2012 production at nearly 20 million ounces.

“And their operating costs are less than $8 for each ounce of silver it pulls out of the ground.

“With silver selling for $32 per ounce, you can see how this company is already making big profits.

“But when the market corrects the silver glitch, this miner could see even more amazing profits than ever.

“Just imagine what its balance sheet would look like with silver at $208…

“That would be an additional profit of $3.4 billion per year!

“That could add another $37 per share to the stock price.

“This silver miner is strong and stable today, with the potential to hand you years of impressive returns as silver snaps upward over time.”

This one isn’t a 100% certain solution, but the best answer provided by the Thinkolator for those clues is … Coeur d’Alene Mines (CDE).

CDE does expect to produce “nearly 20 million ounces” in 2012, though they bumped the “nearly” part down by a million or so ounces when they announced earnings and some disappointing production numbers a couple weeks ago. So you can, if you like, buy the shares for a lot less now — they dropped from about $30 pre-earnings to $23 and change today. Prior guidance had been for 18.5-20 million ounces on the year, but it will now be 18.5-19 million ounces — most of the drop is due to a relatively small problem area at their largest project, the Palmarejo mine in Mexico that they say is “short term” and impacted only production, not reserves (my dumb guy interpretation: the silver is there, they just couldn’t get at it as easily as they planned).

CDE is one of the top ten or so silver producers in the world, and the largest US company in that category, though they do also have a gold mine or two — their big silver mines are in Bolivia, Mexico and Nevada. And yes, they do expect cash costs to remain low, at about $7.50 for this year. So if silver prices skyrocket, they should be quite leveraged to that price … and they do expect 2013 to come in right about the same, with similar production in the 20 million ounce neighborhood. CDE was down substantially earlier in the year, too, and over the past year, two years or five years you’d have been better off owning just silver, but with low cash costs and a rising silver price logic would tell you that CDE should be able to dramatically increase margins, and therefore get a higher valuation. Logic doesn’t always work with miners, unfortunately — I don’t know what CDE’s issues have been specifically this year, other than this quarter’s production shortfall, but miners almost always have some kind of issue … Pan American Silver (PAAS), for example, is often touted as another massive silver producer with great potential but has had headline trouble with their Argentinean mines (don’t want to invest too much if the gummint is going to take them away), and stories of cost overruns, production problems, permitting delays, etc. are leg