2013 has been a brutal year for silver. And a brutal year for a metal obviously doesn't bode well for its mining stocks. Companies that have been exploring for deposits, developing mines, and producing silver have sadly become the pariahs of the markets. But if silver's fortunes change in 2014, as they ought to, then right now could be one of the best buying opportunities of this entire secular bull market.
Unfortunately, silver is currently in a sentiment wasteland. Even contemplating a foray into this metal, let alone its stocks, is a fool's errand to the majority of mainstream investors. Their mindset is why bother wasting even a cent of precious capital investing in a sector led by an asset that's down 36% on the year. It's much more prudent to throw money at the ever-rising stock markets, right?
Indeed the bloated general stock markets have sucked in a lot of silver's capital. With the headline indices all soaring to record heights, more and more investors have joined the herd to chase the gains. This has left little room for alternative investments like silver, fundamentals be damned. And as a result, this metal and its associated stocks have greatly suffered.
The artificially-levitating stock markets aren't silver's only problem though. Certainly the biggest one by far is its association with gold. Sadly gold has endured a panic-stricken year that has devastated the entire precious-metals realm. The mass exodus from bullion-backed ETFs and an anomalous futures-shorting bonanza have left mass quantities of blood on gold's streets. Silver has been unable to avoid the splash damage.
It's no secret that silver's performance is a slave to gold's. It essentially mirrors the directionality of its big brother, with much more volatility on both the upside and downside given its smaller market. As goes gold, so goes silver. So until gold turns, silver will almost certainly remain stuck in its rut.
Fortunately gold is overdue for a massive recovery rally. Even with the rampant ETF selling, it still has incredibly strong structural fundamentals. It should soar on its own merits, but an overdue stock-market correction is sure to accelerate investors' desire to put capital back to work in this sector. For a myriad of reasons, I suspect gold will be the story of 2014.
When gold comes back, so will silver. Silver's gains ought to dramatically outpace gold's, like they usually do. Speculators are naturally drawn to silver in precious-metals uplegs, and they crave upside leverage. This metal still has its own strong fundamentals to attract a more diverse crowd (indispensable industrial usage and essentially the same investment allure as gold).
Silver even has a leg up on gold considering the stability of its premier bullion-backed ETF. While gold's flagship GLD ETF (NYSEARCA:GLD) has seen its holdings fall by a staggering 40% in 2013, silver's flagship SLV ETF (NYSEARCA:SLV) has seen its holdings remain stable. This is an incredible show of relative strength.
SLV's physical inventory happens to be at the same level today as it was at the beginning of the year (324m ounces). This certainly demonstrates strong hands amidst silver's slump. It points to what should be a major boost to this ETF's holdings once investors actually shift capital back to silver.
Finally, once silver again starts to shine, investors will naturally return to the mining stocks. They'll return in droves to chase after gains that normally positively leverage a rising silver price.
The return to silver stocks won't come a minute too soon considering their dilapidated state. With leverage being a two-way street, the silver miners have been crushed amidst silver's decline. This three-year chart of silver and Global X's Silver Miners ETF (NYSEARCA:SIL) shows just how bad things have been for the silver stocks.
SIL tracks an index that is designed to reflect the performance of the silver-mining industry. This index is comprised of companies that mine, refine, and explore for the metal. So in general, the higher the price of silver goes, the more money they make and the more their in-ground resources are worth. And inversely, the farther the price of silver falls, the more their margins are pinched and the less their deposits are worth. It is thus fundamentally natural for silver stocks' directionality to be correlated with silver's.
This correlation is of course visually evident. It is backed up mathematically as well. Since April 28, 2011 (silver's bull-to-date high), SIL has had a daily correlation r-square with silver of 93.2%. This means that over 93% of SIL's daily price action over the last 2.5+ years is directly explainable by silver's own. Such an incredibly high correlation reveals silver's tight grip on its miners' stocks.
As you can see, anything silver has had a rough three-year stretch (SIL in blue and the metal in red). Since silver's April 2011 high, it has fallen 60% to this week. Regardless of how illogical this decline is, it's no wonder investors have been scared off. This brutal selloff has brought silver's price all the way down to 2008 levels.
Silver's plunge naturally fed selling in silver stocks. Over this exact same period, SIL responded with a whopping 62% decline of its own. But provocatively, this comparable loss hardly demonstrates leverage (1.03x negative leverage). As mentioned, the risk/reward paradigm that comes with stocks typically has them outperforming on the upside and underperforming on the downside. Yet if you had purchased SIL on April 28, 2011, you'd be no worse for wear today than if you'd bought the physical metal.
This lack of leverage is explainable if you consider the action prior to silver's apex. Interestingly, there was somewhat of a disconnect between the precious metals and their mining stocks in the first part of 2011. Most investors vividly remember this occurrence, much to our chagrin. On the gold side, the mining stocks didn't participate at all in its final upleg. Gold stocks were essentially flat as the metal forged a series of all-time highs through the first three quarters of 2011.
It wasn't so bad for the silver stocks as measured by SIL, but it was still very concerning for investors. While silver skyrocketed 80% trough-to-peak in its massive early-2011 parabolic upleg, SIL was only able to muster a 36% gain. Why bother owning the riskier mining stocks if their gains can't outpace the metals'? This disconnect really left a bad taste in investors' mouths. And for this reason they lost confidence in the stocks prior to the bull highs achieved in their underlying metals.
Ultimately it was that poor pre-apex action that supported silver/SIL's minimal post-apex negative leverage. It just so happened that in the beginning part of this stretch silver needed to correct sharper than it usually does compared to stocks. As is the nature of parabolas, the downside is just as violent as the upside. Just as we warned at the time at Zeal, silver needed a fierce correction in order to rebalance sentiment. Since silver stocks weren't bid as high amidst silver's parabola, they didn't need to correct as much immediately afterward.
But while the pre-apex action distorts the concept of leverage over this longer-term post-apex measure, by no means has leverage abated. As expected, it didn't take long for SIL/silver to assume their traditional leveraged relationship. On the negative side, silver-stock investors got smacked silly in 2013. With silver down 36%, much of the remnant capitulated. This drove SIL down 52% to this week (1.44x leverage)!
Thankfully investors can cling to the hope of positive leverage even amidst the recent carnage. Silver stocks have been positively leveraging silver's gains for over a decade, making investors fortunes. Despite the fact that stocks lagged in early 2011 (0.45x leverage) and then again in early 2012 (0.81x leverage), positive leverage was bound to return. If positive leverage didn't exist, it would be the end of publicly-traded silver stocks as we know it. There would be no reason to own them.
Fortunately, silver stocks finally started showing signs of life amidst silver's last two uplegs. The Q3 2012 upleg saw silver gain 33%, over which time SIL rose 43% (1.30x leverage). It got even better for silver's Q3 2013 upleg, with an SIL gain of 46% to silver's 33%. This latest upleg gave stock investors 1.39x leverage to the metal, which is improving. I expect this leverage to progressively increase in future uplegs, going from "improving" to great.
Ideally investors would like to see leverage of at least 2 to 1, a nice reward for the risk of owning mining stocks. this is certainly not unheard of based on historic precedent. In fact, in previous uplegs, we've seen precious-metals stocks positively leverage the metals by greater than 5 to 1.
If silver launches radically higher like we expect it to, there will no doubt be a stock-buying frenzy that should lead to great positive leverage. The producers will see their margins skyrocket, the developers will see the IRRs of their prospective operations increase, and the explorers will see the values of their undeveloped deposits soar. It won't take long for investors to realize that the beaten-down stocks are incredible bargains. The gains should be spectacular for those who get in early.
Overall with silver way oversold and due for an epic mean-reversion recovery rally, now is the time to buy the mining stocks. Silver's next upleg is poised to be powerful, and should pull it out of this current vicious cyclical bear. It'll likely lead to the stocks delivering outsized positive leverage vastly better than what's been seen in recent years. This could be one of the best buying opportunities of silver's entire secular bull market.
The SIL ETF is of course a great option for investors who are either new to the silver-stock circuit or who are looking for a more diversified and conservative vehicle. Its holdings are comprised of 29 stocks, of which the majority consider silver their primary metal of focus (those that don't still have strong silver, with their primary metal being gold). It also offers investors exposure to foreign stocks not listed on US or Canadian exchanges (Fresnillo PLC, Polymetal, Hochschild Mining, etc.).
As is the nature of ETF diversification though, there's a limitation on the upside. That's why investors who hunt the big gains tend to go after individual stocks. A skillfully selected smaller basket of stocks will nearly always outperform an index-based ETF.
Picking stocks is of course a daunting task, which is why ETFs are so popular. Not only do you need to have a keen understanding of the sector, you need to understand the intricacies of its constituents. In a period where silver companies have struggled mightily, this understanding is all the more important.
Silver companies have had to weather a double-whammy of a major price decline of their primary metal and a serious lack of funding. Getting pounded by these realities over a multi-year period has led to radical changes in the silver-mining landscape. Unfortunately we've seen somewhat of a sector cleansing, as even some of the former market darlings have struggled to stay afloat.
Picking stocks is more difficult today than it's ever been. The reality is there are fewer quality stocks out there than there used to be. The survivors will perform well once silver starts roaring higher. But the elite ones with a combination of strong assets, savvy management, and solid financials will really thrive. Their stocks ought to seriously outpace the gains of SIL and the sector as a whole.
The bottom line is silver-mining stocks have had a rough few years as they've followed their underlying metal to the depths of its current cyclical bear market. These stocks are universally despised, the ultimate contrarian play.
Silver's fortunes are bound to change in the very near future though. And when this metal recovers, the mining stocks are poised to rocket higher from their radically oversold levels. Now could be one of the best times ever to buy silver stocks. With a skillfully selected basket of individual stocks, the gains brave contrarian investors win ought to be fantastic.
December 27, 2013
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Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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.