A Look at the Silver Market's Recent Past and Likely Future

Includes: SIVR, SLV
by: Mark Thomas

We are having the best year of our twenty plus years of investing and hope you are too. As value investors we aren’t usually in securities or asset classes - or concentrated enough in the right asset classes to be up 55% YTD by just April 15th. We thought now is a good time to go back to take a look at the price targets we set in December 2010, the events of the last four months, and how the silver market is changing rapidly - in order to revise our price targets after the 37% gain in silver year-to-date.

Last fall a weird series of events led us as stock market investors to become concerned that the stock and almost all financial asset classes were being artificially inflated from excess money printing by the Federal Reserve. When Fed Chairman Bernanke in his second interview, claimed quantitative easing was not printing additional currency, his con job fell apart. We thought: How could he tell such a bold faced lie on one of the nation's most watched television programs and have no one even questioned it? What especially galled us was that we knew he was technically correct, that the Fed isn’t literally printing up $600 billion for QE2, but that is what is so misleading because technically what it does is create an electronic bookkeeping entry instead of literally printing fresh dollars. However the effect is the same. The debasement and lowering of the value - and most importantly, the purchasing power of existing dollars. (Just like when a company dilutes your shares when it issues new shares or pays employees with stock options).

So as a conventional stock and bond investor that meant that stocks were risky and bonds offered only downside. We searched for a new asset class and commodities were the only asset class that works with that scenario. More importantly, only two commodities, gold and silver, because the production can’t be increased significantly short-term. They are the only two assets that during inflation when the value of a currency declines are not only a store of value but will actually preserve and grow your wealth’s future purchasing power. We then purchased every book on precious metals and especially silver, scoured the internet for web sites and videos, subscribed to various silver focused newsletters and for the first time in our investing career became precious metals investors. So we exited the stock market entirely in December and went 100% long physical silver back on Dec. 23, 2010.

The 2011 New Year started off with a 13% correction, which was difficult to take but our conviction in our investment strategy is very strong. However that selloff allowed us to go 50% into silver miners, which were ridiculously cheap then and we traded furiously for the next three months and racked up 55% gains for the year. That is beating the stock market by 51% and physical silver alone by 15.89%. However last week the way the silver miners traded changed. Heavy sector rotation started and the stocks all were ahead of their fundamentals. As last week's nationalization threat of mines in Bolivia and the collapse of a tunnel in Hecla Mining Co.'s (NYSE:HL) main mine shows, there is significantly more risk in the miners compared with the physical. Also last week the physical far outperformed the miners, reversing the trend. So Monday morning we sold our miners and went 100% in physical silver, which is where we started from. We think we will remain that way possibly for the next 2-3 months.

Looking forward our investment hypothesis is that silver prices will rise until investors stop investing in it. It really is that simple! Yes silver’s industrial demand is going up, it was and still is undervalued relative to gold and the current world economic and political situation is the perfect storm for precious metals investing. However net new investment demand for silver is taking about one-third of annual production off the market until these holders are enticed to sell. We’re not in a bubble yet in silver but it will end up one. Silver is a positive feedback loop, where rising prices attract more investors and more investors buy physical and physically backed ETFs that take more available silver of the market. That creates rising prices that attract more and more new investors. Eventually the price will be so high it will destroy enough demand and investors will abandon the sector when the price stops performing well.

However, we believe we are in the second of three stages in the bull market for silver. The first was silver acting like an investment again, which began in 2008. Last year we had a breakout that began the second phase where investors become interested again and aggressively buy. The third phase will be when the public rushes in and clamors to buy no matter what the price. When that happens you will see price moves that are 200-300% the current ones. That along with some other time-tested ratios of silver vs. the average price of a US home, gold, the Dow and oil will tell us when to exit. However the main factor we will have to judge and closely monitor is net new investment demand. Most silver bulls don’t subscribe to our theory but that is because they are not used to the cycles that investors in regular financial assets engage in. Precious metals moves in cycles that might last ten or twenty years. For stock investors that is an eternity and emotions are that much greater both on the positive and negative side.

We’re revising our 2011, 2012, and 2013, price targets slightly after the huge run so far in 2011. We increased our price target for 2011, from $50 to $55. We upped our 2012 price target to $85. Our final price target for the end of 2013 is still $120. We still expect silver to reach $120 in a little more than the next two and a half years, to go up another 181% from current prices. For now we are 100% invested (in our retirement accounts) in the ETF Physical Shares Trust (NYSEARCA:SIVR) and intend to stay that way for quite a while. Forget the hassle of stocks right now, they're still in a sideways churning market where the potential risk far outweighs the potential. We feel the events of this year have confirmed our observations and investment strategy and are very pleased our subscribers are benefiting so handsomely following our lead.

Disclosure: I am long SIVR.