Silver Miners Oversold for No Good Reason

by: Erik Wright

As most investors are aware the markets have been extremely volatile this past month. Most of this volatility can be attributed to a wide range of issues that have got investors quite worried; going from the Europe debt crisis to a sluggish American economy, which is itself up to its ears in debt. It seems every day the sentiment is growing more and more pessimistic about the hopes of a sustainable recovery.

Although the past month has been dismal in terms of performance for the S&P 500 (NYSEARCA:SPY) and equities in general, gold (NYSEARCA:GLD) and silver (NYSEARCA:SLV) have been running upward. By simply looking at the past month, the comparison between the S&P 500 (SPY), GLD and SLV, the graph clearly demonstrates the disparity between equities and these shiny metals.

(Click charts to enlarge)

Investors have been using gold and silver as a flight to safety, as well as a way of protecting themselves against the loss in value of the USD, which could be accentuated through further quantitative easing. South Korea and other emerging market central banks have been drastically increasing their gold and silver holdings. In a recent Forbes article Jeff Clark, senior precious-metals analyst with Casey Research emphasized that:

“So far in 2011, central banks in the emerging markets have already bought more than double the gold they bought in all of 2010, and we’ve got almost five months to go for the rest of the year,”

China itself has been demonstrating to its citizens the value of investing in silver and last year China accounted for 23% of the worldwide silver demand alone. China's new mercantile exchange is also making it much easier to have access to silver and silver contracts, which should also help increase Asian investor's demand for metals.

Focusing simply on silver, the metal has performed fantastically this recent year but miners themselves seem to have been left in the dust. The following chart demonstrates a few silver miners in comparison to the metal itself (SLV).

Oddly, as shown above there has been quite a discrepancy between the metal and the companies mining the metal. This seems quite strange since evidently when the price of the commodity that a company is selling goes up so does the company's profits, therefore the share price should follow. But in multiple instances the price of silver went up while the miners fell. Some explanations given for this are that people would rather hold the physical asset rather than owning a company. Some believe that buying a gold or silver company puts you not only susceptible to commodity specific risk but also company specific risks such as regional, political and financial risks.

Although I agree with that ideology it is hard to ignore a few of these silver companies even with stellar growth, solid capital structures and rising silver prices, have yet to rally in tandem with their specific commodity.

Another reason silver companies are oversold is that most of them use oil and gas to operate mining operations. Being such a significant cost, the recent decline in oil should be helping these companies increase profitability.

Yesterday's drastic decline has made many of these silver miners drop like a stone, many declining over 10% in one day. The selling can be mostly attributed to investors selling to avoid a margin call due to a sudden drop in the value of their portfolio. Others also believe this sector is a place where lots of manipulation occurs from the bigger institutions and hedge funds that help accentuate the drop in severe declines to entice fear upon the retail investors to later get in at more discounted prices. Lastly, the overall market got sold off drastically, many fleeing back to the USD, treasuries and raising cash by selling all types of equities.

Many of these silver miners are nearing short-term oversold levels and may be due for a rally. It could be a great opportunity to capitalize on these extreme declines by picking up some solid companies in the silver and gold sector. Based on technicals I would advise caution and waiting for a confirmation of a reversal pattern before entering in a position, because silver companies have yet to show a sustainable intra-day reversal pattern. Based on fundamentals, many of these companies are very well off financially and have incredible future growth prospects. Therefore, they could become very feasible long term investments if picked up at discounted prices.

Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in SVM over the next 72 hours.