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Silver Closing In On Phase Three?

|Includes: NLR, iShares Silver Trust ETF (SLV)

A YouTube search for “CNBC Silver” yields a total of 10 segments from CNBC on silver within the last month. Personally I remember just a month or more ago where there were no segments on silver at all. Mad Money’s Jim Cramer says to “buy the physical”. In one clip from last week, CNBC covered traders of physical metals from coin shows who would “buy it in the morning and sell it in the afternoon”. Of course, none of the examples provided can be used as concrete evidence that silver is “topping” nor am I suggesting to anyone to liquidate their silver equity, but my point is that I am hearing more noise from outside of the sector and from within that is disturbingly bullish. We do know the fundamentals are strong, but the big story in the silver market has always been the eye-opening misvaluation by the market as the price had been suppressed for years.

With more and more traders getting on board in the last 1-2 months, the valuation story has significantly lost it’s luster. Silver bears and silver bulls previously conceded that the price had been extremely overbought at $25. At that time, I agreed but I still saw tons of value there as it had not literally gone straight up yet. From August 2010 to December 2010 silver gained $13 dollars in roughly 5 months. It appears now that they are even less silver bears out there and the silver bulls are awestruck of the recent $16 move from $26 to $42 in 2 and a half months. If I’m wrong, that’s fine with me because I’ll still on board for the ride, but since I don’t see too many others who are willing to go on record and say that silver is dangerously overbought here, I’m going to go ahead and make the case.

Tekoa Da Silva from Contrary Investors Cafe recently suggested that people buy uranium stocks instead of silver at least until it is clear where silver may be headed next. Any why not? Everyone hates uranium stocks right now and just about everyone wants to be in silver.

The simplest, most spot-on, yet sometimes difficult advice for traders is to buy low, sell high. Do you want to be to trader that buys silver when it is worth less or equal to uranium? Or would you rather buy when it has gained 100% versus uranium in the last year with 84% of it being in just the last 2 months? If the gold silver ratio falls another 20x, silver could go to $140 or $150/oz. That would be roughly about a 350% increase. Uranium, thorium, and rare earth oxides are other examples of assets that can do the same or more but have not come even close to performing the way silver has and are largely undervalued and underreported. In fairness, we’re not talking about nuclear and alternative energy assets, we’re talking about silver. However, my point is that silver bulls started by being contrarian and now it seems as if most of us are wearing the blinders when it comes to what’s been happening. Of course, these things can go on for a while and if the mania phase is set to happen now, then, as popular YouTuber and silver guru StellaConcepts recently said, so be it. Be prepared to hear all of your friends who wouldn’t listen to you at all become experts on precious metals and start telling you about the P/E on silver companies as if price to earnings is an effective way to value resource stocks. And most importantly, enjoy the profits.

The ECB rate hike

Though it’s my belief that a large reason for the increase in the price of silver is driven by consumption in emerging markets, investment demand, which is still by far the largest source, is driven by traders in the US who use commodities as a hedge vs the dollar index – which brings me to my next point – the euro, which makes of 58% of the dollar index weighting, is overvalued versus the dollar.

The interest rate hike by European Union has been a major catalyst for higher equity and commodity prices over the last week. The question is, why did it gap higher after the news came out if all economists in a Bloomberg survey predicted the move months in advance as well as it largely being the consensus on Wall Street that it would in fact happen? Let’s delve even further… how is does interest rate increase make for a strengthening euro if it’s already the consensus that Portugal, Greece, Spain, and Ireland will need one or more, or many more bailouts in the future? If this increase in interest rates does indeed become the “first in a series” then the cost to service the bailouts rises and ultimately it will create a debt spiral for the EU. Riots continue across Europe because governments can no longer afford to make good in the benefits and handout packages that they once promised. Luckily for those in the US, we don’t have that problem here quite yet. I can say with complete certainty that the countries in Europe will have to deal with more rioting and more defaulting by inflation in the future, well before the US will have those problems.

On the other side of the coin, the dollar is everyone’s favorite currency to sell.

From Yahoo:

US Dollar sentiment and positioning shows that large speculators continue to bet on weakness, warning against taking aggressive bullish positions in the downtrodden US currency. Yet the potential for material reversal is growing amidst high leverage on Greenback-bearish bets.

Risk reversal is as follows –

1 week 61.69%
1 month 68.39%
3 month 64.33%
1 year 77.78%

Commercials are largely still betting on dollar weakness which explains the smaller short term spreads, but the 13.45% spread between the 3 month and 1 year reversal is triple the size of the other spreads which means that the dollar can continue to show weakness in the short term, but institutional bets may change dramatically over the next 6-12 months. Inflation in the US has moderately outpaced EU inflation over the last 12 month by about a tenth of a percent per month. However based on CPI, EU inflation rose in March to 1.1% compared to .5% in February. Also, inflation in the euro area rose 1% from .4% in February to 1.4% in March. Meanwhile, yields on Greek debt are over 13% and yields on Portuguese debt are pushing 9%. This too has yet to translate into the market.

Speaking of Greece and Portugal, another thing that has been questionably excluded is the Portuguese bailout. The Greek debt crisis last year was more than enough to drive to DJIA back below 10,000 after QE 1 expired. We’re getting close to the end of QE 2 as Portugal nears a $100B+ bailout package to stop their government from shutting down.

So, what happens if some catalyst takes place like the exchange rate failing to break the pivot top at $1.45 as QE 2 runs out and no immediate program is publicly announced? Does the euro rally forever as the dollar falls below 70 and commodities skyrocket? From a fundamental point of view I seriously doubt it. But, if we are reaching mania phase then certainly silver can go higher as retail volume increases regardless of other measures. I’m still very sold on the long term fundamentals but for me to be a strong buyer again, I’d have to see silver hit a top as soon as possible, retrace about 15-20% and sit in a trading range for several months until the pundits stop promoting it and the talking heads begin bashing it once again. Until then, I’ll remain in silver with a trader’s strategy and not risk any long term capital that I cannot liquidate should I need to.