Massive Silver Correction Makes Silver Incredibly Cheap

Posted 23 Sep 2011

[pullquote]Lately, my crystal has been clouded.[/pullquote]The European turmoil is roiling global markets as counterparties increasingly distrust each other's collateral leading to the liquidation of pretty much everything.

The mantra must be, "If there is a bid then hit it." This daily noise has opened up some tremendous buying opportunities. Chief among those opportunities is silver.


On 19 Sep 2011 I wrote about gold and silver consolidating, "The real value seems to be in palladium which is trading at an extreme discount of 0.9224x its 200 day moving average."

This was because statistically speaking palladium was extremely outside the standard deviations of its usual trading ranges relative to its 200 day moving average. The 200 day moving averages acts like gravity to filter out the daily machinations of the market.

In a secular bull market, like the precious metals are currently in, when silver moves below 0.95x the 200 day moving average then a buying opportunity presents itself where the probability of a gain on the position relative to the numeraire is much more likely. On 23 Sep 2011 the price of silver is $30.45 and the 200 day moving average is $35.76 which yields a relative price between the two of 0.8516x.


This ratio has never been lower in the past decade except shortly after Lehman brothers collapsed. Within a year the price had doubled. Within three years the price had gone up five-fold. The current correction and ensuing consolidation is setting the stage for a triple digit FRN$ silver price.


But the savvy investor may ask, "But is not gold the proper numeraire?" Yes. Sure, this chart is showing silver through the FRN$ lens. The gold to silver ratio, currently around 48 ounces of silver per ounce of gold, does tell a different story.

Silver is not nearly as cheap today as it was in the early part of the decade when the ratio was over 100. But as this secular bull market progresses the ratio should continue declining.

It will likely reach 16:1 and may even overshoot to 8:1 or as some rather bombastic commentators have made the case it may even go to parity, 1:1, or it may actually take more than one ounce of gold to purchase one ounce of silver. While it may seem unbelievable and in my opinion a low probability I do not think it is a completely unrealistic scenario.

Currently it takes less than one ounce of gold to buy one ounce of platinum. Platinum is much scarcer than gold, there is less platinum produced per year.

Since the Lehman Brothers collapse the gold to silver ratio has moved from about 80 to 40-45. While gold is the better numeraire; silver has been the superior speculative currency. Remember, you make money when you buy not when you sell.


Six years ago South African gold market analyst Peter George said at GATA's Gold Rush 21 conference in Dawson City, "In the last 10 years the central banks have effectively shown that when there's a real crisis, gold actually goes down, and it's so blatant, it's a joke." The central bank script has not changed.

But we do know that price controls lead to shortages. Last time silver got this cheap there was silver backwardation for weeks while the price clawed higher to clear the market.


[pullquote]Remember, you make money when you buy not when you sell.[/pullquote]CONCLUSION

Following provident living principles I like to accumulate the precious metals on a regular basis usually in proportion to excess free cash flow. Like Rick Rule I am a fear investor regarding them and rarely do I move into them based on the greedy speculative component. There are other less manipulated assets for that purpose.

But in this case the markets have been in major liquidation mode and silver has not been spared. This has opened up a tremendous buying opportunity.

But due to the large amounts of manipulation in these markets I would caution against the use of leverage. This is just the latest step in a long staircase of The Great Credit Contraction.

DISCLOSURES: Long physical gold, silver and platinum with no interest in DOW, S&P 500, the problematic SLV ETF, gold ETF or the platinum ETFs.