Debt Ceiling Agreement: Short Selling Silver Again

Aug. 1.11 | About: iShares Silver (SLV)

Let us start with my article from May 3, 2011 on Seeking Alpha titled Silver Demand Theory Debunked. The chart shows that I exited my long silver position right at the top. On the last tranche, I nearly tripled my money.

In the article I also advocated short selling silver and stated in clear, unambiguous language that based on the Quantitative Screen of the ZYX Change Method, the fair value of silver was $34. The chart shows what silver has done since the publication of the article.

My conviction based on rigorous analysis of the data using the proven ZYX Change Method was so strong that I took the rare step of recommending a double inverse ETF ProShares UltraShort Silver (ZSL) in a ZYX Buy Change Alert. This recommendation was unusual as this service normally focuses on long positions. Of course, for those who could short sell, the preferred vehicle was iShares Silver Trust ETF (SLV). I, along with my subscribers, generated the biggest returns by short selling a publicly traded vehicle, which at that time was selling at 22% premium to the value of underlying silver.

When silver hit our target of $34 in a matter of days, we sold ZSL and covered shorts on SLV and silver futures. I advocated that subscribers with small accounts also buy to cover shorts in the special silver vehicle mentioned above. As silver moved back up, we started slowly accumulating a small short position in this special vehicle again.

As I write this article on the evening of July 31, 2011, I have just taken a short position in near term silver futures at $39.82. There are better ways to short silver, but the futures market is the only open convenient market.

The immediate trigger is the report that an agreement on the debt ceiling in Washington is near. The debt ceiling uncertainty has added about $2.50 to the price of silver.

The world economy is slowing. At The Arora Report, we monitor leading economic indicators from 23 countries. Our forecast is that the world GDP will grow by 0.5% less than the consensus over the next two quarters.

Silver is also an industrial metal. Slower economic growth reduces industrial consumption of silver. Estimates of silver demand over the years have varied widely, depending on the source. In 2001, silver demand was in the range of 850-900 million ounces. By 2009, silver demand was in the range of 875-925 million ounces. This was not a meaningful increase when compared to the global GDP rise for the period.

In 2010, pent up demand from the recession materialized, pushing up silver demand to the 1025-1075 range.

We previously estimated that the industrial demand in 2011 would be 500-550 million ounces compared to 540-575 million ounces in 2010. Due to the slower growth we are projecting, we now estimate the silver demand in 2011 to be 500–520 ounces.

The slower growth should take approximately another $2.70 from the price of silver. This leads again to a target of about $34.

Please understand that this call is only for nimble traders. Unlike my last call, this call is not for a typical investor. Further, even with my recent addition, I will be holding only a small fraction of the full core position size. This gives me a lot of flexibility in adding to the position if the price goes higher. Subscribers may also be holding a small fraction of the core position size in a silver-related short.

Disclosure: I am short silver.