Government shutdown! Shouldn't this be good for the metals? I mean, doesn't this mean there will be panic, anarchy and the end of civilization as we know it?
Ok, in all seriousness, one of the reasons the metals are selling down is because many traders are cashing in on short-term gains that we had when the most recent bottom was found in gold around $1,180 and silver around $18. They are locking in profits. Technically, both have fallen through support. Fundamentally, people are seeing this shutdown as a potential spark that could lead to the government finally cutting spending in the long-term. Less spending=less debt=bad for gold and silver. Short-term traders like it when it seems the U.S is on a path to being bankrupt. Long-term holders realize that is somewhat already the case and welcome this decline.
I believe you should be taking advantage of this selloff thanks to the government shutdown, especially those who have been on the sidelines waiting to start a position. Today is a great day to open up a position in precious metals as the long-term fundamentals are intact as I will highlight in this article. This pain that we are experiencing adds to the historic 2013 sell-off in silver (SLV), as well as gold (GLD). However, despite the short-term shenanigans leading to volatility, these depressed prices have given investors an excellent chance to accumulate a long-term position in physical holdings and individual companies.
It is my opinion that as the price of both gold and silver have come down you long-term investors, not "traders," should dollar cost average and/or pyramid down into gold, silver and precious metal equities in order to have a small position in their portfolio devoted to this sector. I always recommend about 10%. Interestingly, I really like silver more than gold, and in this article I will explain why that is the case. But before anyone pulls the trigger on silver related investments, one must ask what the catalyst will be to cause a surge in silver prices?
One of my primary hypotheses, the details of which I laid out in the background section of this older article, is that the endless easy money policies from central banks around the globe have created a long-term tailwind for the various precious metals. Many on the other side of this trade disagree with this assessment, and some question it historically. However, I maintain that only time will tell which of us is right. Despite the short-term pressure on the metals, the Federal Reserve's continued accommodative and dovish policies should create a weaker dollar in the long run, lead to eventual inflation and in turn, bolster the prices of gold and silver. This thesis rests on silver being treated as a precious metal. Precious metals hold value and increase their buying power when inflation ticks up. While this has yet to occur in the U.S., it will be a likely result of a diluted money supply. While gold is the ultimate hedge against inflation, other precious metals, such as silver, platinum and palladium, all tend to move higher when inflation creeps up.
Gold Is Great…
Demand for investment gold is universally very strong, particularly among physical investors. Earlier this year, the U.S. Mint ceased production of the 1/10th oz American Gold Eagle due to record demand. This was a sign of record buying, but what is more interesting was the recent World Gold Council Report, which highlights the demand worldwide. There is some demand in industry and technology, but cheaper more durable metals are now being used. However, demand has been stable, holding around 100 tons over the last year and a half. Some highlights from the report include continued strong demand in jewelry, particularly in India. The report also suggests a decreased demand for investment gold, but further investigation reveals that the decline in investment demand relative to Q1 2012 was solely attributable to the net outflows from ETFs, which obscured the strong rise in investment demand for gold bars and coins at the retail level. Central banks also added 109.2 tons of gold to their reserves in Q1 2013 and more in Q2, marking ten consecutive quarters of net purchases. And what about global supply? For the first quarter of 2013, there was supply of 1,050 tons. This was little changed from first quarter of 2012 but also means central banks purchased 10% of the world's gold supply during the quarter. Furthermore, the US Geological Survey reveals that gold mine supply has dropped every month in 2013. Thus, less gold is coming to market. With less gold coming to market, obviously supply is decreasing in the face of steady and/or increasing demand. Eventually, the laws of economics will catch up.
It is painful to be a holder of gold, particularly if you have purchased in the last year or so, to watch the value decrease while demand is so high and supply is diminishing. However, for the long-term, it is worth holding onto your metals, or buying at these levels, despite the fear that is prevalent in the market. If central banks are huge buyers at these prices, it would not be illogical to purchase some as well.
Top Way To Play Gold
In my opinion, the best way to invest in silver is through physical bullion or coins. This is primarily how I personally invest in the space, though I have utilized some of the paper approaches I will discuss below. There are dealers in most cities and merchants on the Internet where you can buy silver bullion bars and/or coins. I not only consider physical silver as a wise investment given government stimulus, but I also consider it to be a form of insurance in case of a total breakdown of the fiat currencies and modern financial systems we have in the world today. If you choose to invest in physical silver assets, do so by only buying from a reputable dealer. The only downside of Internet purchases is high shipping and insurance costs as well as the possibility of a required minimum purchase. Whenever possible, buy locally to avoid such excessive shipping and handling fees.
You Could Buy A Gold ETF
Other options exist to track the price of gold. There are several ETFs that can be purchased. The first is the SPDR Gold Trust. It holds gold and issues shares in minimum blocks of 100,000 (also referred to as a basket) in exchange for deposits of gold and distributes gold in connection with redemption of these baskets. The investment objective of the GLD is for the shares to reflect the performance of the price of gold bullion. GLD currently trades at $123.95 with average daily volume of 9.2 million shares. It has a 52-week range of $114.70-$174.07.
Another option that I prefer over the GLD is Sprott Asset Management's Physical Gold Trust (PHYS). This is not a traditional ETF, but is rather a closed-end fund. For investor purposes, this distinction is not overly important but there are subtle differences. More about closed end funds versus ETF can be found here. PHYS invests in unencumbered and fully allocated London Good Delivery gold bars. Sprott Asset Management created PHYS to invest and hold substantially all of its assets in physical gold bullion. Management invests in long-term holdings of unencumbered, fully allocated physical gold bullion and does not speculate with regard to short-term changes in gold prices. It does not purchase, sell or hold derivatives nor does it invest in gold certificates or other instruments that represent or may be exchanged for gold. Besides holding some cash, approximately 98.9% of net assets are directly invested in physical London Gold Delivery gold bars. I much prefer this over the GLD because of its physically backed nature. PHYS currently trades at $10.66 with average daily volume of 400,000 shares. It has a 52-week range of $9.81-$15.42.
...But Silver May Be Better
You know, gold has long been considered the best of the precious metals, but as its price has been driven up, retail investors have turned to silver as an alternative precious metal. Unlike gold, the great thing about silver is that there is huge industrial demand as well (okay, gold has some uses, but silver use far outweighs it, literally). The second key driver that I believe could cause a surge in silver off the recent lows in the next few years is the multiple sources of growing demand for the metal, in particular the technology and medical sectors. However, there is also incredible demand for silver as a precious metal as well, making it a win-win situation regardless of the economic situation long term.
Demand for Silver is at All-Time Highs
Demand As A Precious Metal
A lot of hardcore silver enthusiasts may know this, but it is likely the average Joe does not. Here in 2013 there was a significant shortage of both American Silver Eagles from the US Mint as well as junk silver available (that is, pre-1965 US dimes, quarters and half dollars) as a direct result of record high demand. Further, silver ETFs have continued buying silver bullion at a record pace. Thus, demand for the metal as a precious holding is there from physical investors, and has helped get silver back to the $24.00 mark. Aside from silver being a precious metal, it also has many industrial and technological applications. Therefore, there will always be some level of demand, but such demand should pick up significantly when the global economy comes fully out of recession.
Despite the stock markets in the U.S. setting all time highs, the broader economy is still just limping along. The most recent GDP numbers have been weak, reflecting expansion of just 2%, which is well below prior estimates for this time in 2013 of 3.0%-3.5%. Further, the jobs picture has yet to improve markedly, though unemployment has come down, albeit slowly. This slow growth has led to industrial demand for silver, but the growth is slow enough to keep the Fed on the easing accelerator, which bolsters the precious metal side of the metal.
Demand As An Industrial Component
When the economy rebounds, there will be a spike in demand in many areas. The demand will not be just in coin and bullion form, but also in jewelry, silverware and dentistry. On the technology front, silver is one of the most conductive metals out there, and thus is utilized in photography, electronic devices, optics, medical devices/tools and most recently, in nanotechnology. One of the factors driving the forecast improvements is demand for ethylene oxide, an intermediate chemical in industrial processes that requires silver. The production of that and other intermediaries will help the US run counter trend to other industrialized nations, which according to Thomson Reuters GFMS will see slow growth. In absolute terms, the GFMS expects China to achieve successive record highs in terms of its industrial use of silver over the forecast period, along with the U.S.
Robust growth in demand from the auto sector is also expected, and will help further underpin the performance of the electrical and electronics segment. Auto production is expected to rise, boosting silver usage due to the growing number of units. However, auto-related silver demand has already outpaced production because of the growing number of electronic accessories in each unit. GFMS expects this trend to continue as features once reserved for luxury vehicles become more standardized. Improvements in the economic backdrop are also expected to boost silver demand from the housing and construction industries.
As we further delve into an era dominated by Apple (AAPL) iPhones, iPads etc. and its competitors' similar products, demand for silver grows heavily. Apple with its millions of iPhones sold has created massive industrial demand for silver. As its sales are strong, this demand will continue. In fact, there is an average 16 cents of silver now used in each cell phone. While that is not much for a single phone, considering there were nearly six billion mobile subscribers worldwide in 2011-2012, a number that's growing here in 2013, it becomes clear that new phones will always be in demand. Using the average of 16 cents a phone, we generate demand for about $1 billion worth of silver in just new mobile devices alone. There is a lot of silver in old cell phones, photography chemicals or medical devices that already have been taken out of the market. Although there is a push to recycle electronics and reclaim costly elements like silver within them, in situations where silver is used in very small portions (such as new smartphones), it is not cost-effective or even practical to recover the silver. Thus, new silver will be utilized in these devices.
Silver Supply Eventually Won't Meet Demand
Realize that megatons of silver are consumed in industrial processes, and while sometimes recyclable, silver is often discarded into landfills, never to be recovered. It is said that 99% of all gold ever mined is still in existence above ground. For these reasons, silver stockpiles as a percentage of all silver ever mined is so much smaller than gold stockpiles as a percentage of all gold ever mined.
During the 1950s silver was consumed in a variety of vital modern applications at a phenomenal rate. In 1998, known stocks of silver had shrunk over 95%, to around 500 million ounces. The nine and a half billion ounce draw down in total silver inventory was the result of the persistent shortfall between supply and demand, which continues to this day, and has likely accelerated. During the late 90s the 200 million-ounce annual deficit mirrored the long-term trend line average. This continuing deficit is remarkable in that there has been decent growth in world production of silver over the past 50 years, but obviously not enough to satisfy the surge in industrial demand. Because demand for silver is unprecedented, not just for precious metal investment, but in industry, particularly in technology, I see this trend continuing. Eventually we will likely not have enough silver to meet demand. The end result will likely be intense recycling initiatives and a rising long-term price, in my opinion.
This is a huge red flag (silver flag?). It's not some warped belief or manipulated statistic. I am not a silver bug salivating over bullion in my fortress of solitude. The fact is, the laws of supply and demand will eventually catch up to silver prices. It bears repeating, in smart phones alone, over $1 billion worth of silver is utilized annually. Add a few another billion dollars for all of the computers, tablets and televisions sold each year. Now think about all of the other industries using silver (jewelry, dentistry, nanotechnology, etc). It is in finite supply with ever increasing demand. Eventually, this needs to normalize, and when it does, silver prices stand to benefit, and I believe that tremendously.
From a Technical Perspective, Look to the Gold-to-Silver Price Ratio
What about all of the technical experts out there? While I'm a fundamentalist at heart, it's good to have the technicals on my side, too. At the time of this writing, silver is priced around $24.05 an ounce, approximately 52% off its recent highs set in April of 2011. Gold is currently priced at about $1,397 an ounce. That represents a 58.1 to 1 gold-to-silver price ratio, whereas the historical ratio is 16 to 1. Now granted it has not seen that ratio in many years. The respective prices of gold and silver have not approached this historical ratio since silver was widely used in common currencies. However, I believe a reversion is long overdue toward, at a minimum, the more modern ratio of 50 to 1. To achieve this reversion, gold would have to fall to $1,175 an ounce while silver remained stagnant, or silver will have to rise at a greater rate than gold in value in the coming years. I believe the latter is far more likely than the former, especially in a climate of endless monetary easing as well as unprecedented demand in the technology sector. Combine this with the fact that industrial demand will return in full force once we have moved completely out of the recession and we have a strong case for an investment in silver. The ratio has crept up year to date, but it has generally been in the 45-55 range for some time.
Now, Just How Can You Play The Rebound In Silver Prices?
Generally speaking, there are three ways investors can get exposure to silver. My top approach for silver exposure is purchasing physical silver bullion and coins, followed by purchasing shares of ETFs that track silver prices, and finally through the stock of the individual silver companies/miners.
Physical Assets Are Also My Preferred Method of Owning Silver
Just like gold above, the best way to get in on silver is to pick up physical assets. Whether it be coins, bullion or junk silver (that is currency that is made up of anywhere between 35%-90% silver), this is my preferred way of owning it. For more about how to purchase physical assets, see the section on gold above.
One option every silver bull should consider for paper profits, especially those who do not feel comfortable purchasing physical silver, is through buying units of an ETF.
One of the most popular options to get silver exposure is the iShares Silver Trust. This is ETF tries to reflect the price of silver owned by iShares minus expenses and liabilities. The fund is intended to constitute a simple and cost-effective means of making an investment similar to an investment in silver. Now, although the fund is not the exact equivalent of an investment in silver, it provides investors with an alternative that allows a level of participation in the silver market through the securities market. The fund has $8.1 billion in assets with an annual expense ratio of approximately 0.49%. Although SLV tracks the price of silver, if silver were to remain stagnant for all of 2013, say at $22 an ounce, then SLV would lose value given the fees and expenses. Overall, it does a good job of tracking silver price moves in general, but this caveat is important to consider for a long-term investment. Shares in SLV currently trade at $19.90 on average volume of 11.2 million shares and have a 52-week range of $17.75-$34.08.
Another way to get silver exposure that I really like is the Sprott Physical Silver Trust (PSLV). The PSLV, much like PHYS above is a closed end fund, not an ETF, that is backed entirely by physical silver bullion. The fund's goal is to provide a secure, convenient and exchange-traded investment alternative for investors who want to hold physical bullion. The Trust offers a number of compelling advantages over traditional exchange-traded bullion funds, including bullion storage in Canada, which is not held with a bank-owned custodian. Further, the fund allows investors to redeem units of the ETF for delivery of an equivalent amount of physical bullion. In this regard, the fund is unique relative to SLV and other ETFs that track silver. It is perhaps the best way on paper to invest in silver. Currently PSLV trades at $8.29 a share on average daily volume of 1.3 million. The 52-week range of PSLV is $7.16 to $14.34.
Individual Silver Companies
For the risky investor, the final option to consider is the silver companies/miners There are plenty of individual companies that I really like. See my other articles for my favorites and why. Overall, I really like Silver Wheaton (SLW) and its streaming business model better than other silver miners that actively produce the metals. The company, based upon its current agreements, forecast 2013 attributable production is approximately 33.5 million silver equivalent ounces, including 145,000 ounces of gold. By 2017, annual attributable production is anticipated to increase significantly to approximately 49 million silver equivalent ounces, including 180 thousand ounces of gold. Other than its initial upfront payment, Silver Wheaton typically has no ongoing capital or exploration costs, and the company does not hedge its silver or gold production. The company has projects/agreements and is developing projects globally. It's a long-term winner and a bargain at its current price of $23.80.
The best way to gain exposure to silver miners as a whole for those who do not wish to pick just one is through the Global X Silver Miners ETF (SIL). SIL currently trades at $16.15 on average daily volume of 173,000 shares. SIL has a 52-week range of $10.54 to $25.75. For those willing to take on more risk and do the necessary homework, an individual silver company such as SLW, or another miner I have recommended in prior articles could be considered in place of SIL, which potentially could offer better returns. However, SIL will offer exposure to the whole sector.
Take advantage of this "government shutdown selloff." Use this weakness if you have been on the sidelines waiting to pick up some exposure on the cheap. For those just getting started, it's the perfect time to start your long-term positions. I maintain that long-term precious metals stand to gain significantly from balance sheet expansion at central banks and currency debasement despite criticisms that this will not happen. While gold is an excellent play off of the stimulus coming from governments worldwide, I believe silver and silver companies may outperform gold in the next few years. Regardless of the precious side of silver it has massive industrial demand, particularly in the technology sector. Physical holdings are my preferred way to go, but the ETFs and companies mentioned in this article can be very profitable. Further, the list I provided is just a sample of ways to play - it is not nearly exhaustive. While I'm also adding to gold holdings, at current levels of $20.65, with the long-term fundamentals very positive, I believe silver and subsequently silver companies are significant opportunity buys over gold plays, especially for the long-term investor. In the end, this shutdown is just a sideshow in a long process of the US government spending its way into oblivion. This reason. among many others, is a reason to allocate some funds to gold and silver.
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 (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: I own physical gold and silver bullion.