Sunday, September 12, 2010

Protecting Capital from Fed's Activities, Part 2: Focus on Silver

In the initial part of this series, I focused on gold as a way to protect capital from loss of purchasing power due to Federal Reserve policies, but also discussed silver (which has risen about 4% in price since then) and certain foreign currencies as ways for Americans to potentially protect their wealth by ownership of these assets.

In this post, the main topic will be silver. Here's some further background discussion before getting to silver specifically.

I am presenting herein my opinions and what I believe to be facts, but the facts have not been fact-checked and there may be some inadvertent errors, including typos; apologies if such proves to be the case.

The Federal Reserve has taken and continues to take extensive actions to keep short-term interest rates below the rate of general price rises in the broad economy. It has done this in concert with the policies of the current and immediately prior administrations.

I believe that Fed-induced monetary inflation is likely to show itself via further general price increases, which will tend to accelerate under steady-state economic conditions.

The bogeyman of "deflation" has been scaring people into buying bonds after a 29 year bond bull market, and unlike Japan, where zero interest rates have taken hold with clear stability or even mild decline in consumer prices and therefore have not been adverse to savers, the same policy in the U. S. continues in force despite positive consumer price rises which are greater than the near-zero Fed interest rate policy.

The Fed has been deliberately costing savers money in real terms. It has been doing this while protecting stockholders and bondholders of financial companies.

I object to this policy (these policies) and believe that as in World War II, the full force of the government and the mainstream media has been marshalled to sell people debt instruments that the government (through a compliant central bank) intends in good measure to inflate away rather than repay in full and in good faith.

It is, of course, possible, that the U. S. will have a Japanese outcome, with less and less price increases and out-and-out deflation, with resultant continuation of the bull market in bonds. However, as I understand it, Japanese investors waited till there was actual price declines in their cost of living before driving the yield of the 10-year government bond to or near 1%.

U. S. policy has been actually been quite inflationary from 1933 onward, with the exceptions of brief periods of Fed tightening; a good part of the 1950s, when there was both peace and a president who actually believed in balanced budgets; and with the partial exception of the early Volcker years as Fed head. Further, many people also don't realize how major the Iraq-Afghan/AfPak Wars are from a direct budgetary standpoint (even ignoring the indirect costs), and as with the Viet Nam War, Congress has made no attempt to fund the war by raising additional revenues. The Viet Nam War provided the final nail in the coffin of a gold-backed dollar (see Nixon, 1971 - closing the "gold window" for a unique take and HERE for a more thorough, standard take) and it helped lead to massive inflation. The Fed had begun accommodating first President Kennedy and then President Johnson monetarily ("stimulus") before prices were noticed to rise throughout the broad economy.

I think something similar is happening now.

President Johnson pursued a guns and butter approach, but it was small beer compared to current and recent policy. When LBJ escalated in Viet Nam, there was no Medicare and no Medicaid, and Social Security took in much more in taxes than it expended. Thus the money-printing has crossed the previously unthinkable threshold of direct Fed purchase of Federal government debt, something that was only supposed to happen "elsewhere". Not in America. But it has now happened twice. 2009; 2010. Sic transit gloria.

In that context, silver may be both a sensible addition to gold and foreign currencies for the part of a financial portfolio that attempts to preserve capital in real terms. This article does not represent investment advice. It also does not look at silver as "money", in contrast to the official monetary metal, gold.

The nearby chart (click on it to enlarge) shows silver prices in both real terms and in relation to gold over the centuries, beginning with 1344. Not shown are reasons why silver became less useful. These include the mass production of stainless steel "silverware" and, more recently, the advent of digital photography.

This chart demonstrates that silver's price has lost ground in real terms over the centuries. Silver is and has been a speculative investment in a way that gold is not. However, "real" returns are a difficult metric to match when the Fed is inflating the value of "money" away at a rapid rate.

(Click HERE to link to the site that gets one to this chart and to many others, including a similar chart for gold.)

It is possible that over the intermediate term, an asset such as silver may simultaneously fail to keep up with the rate of general price increases yet rise in nominal terms more than the interest rate available to an individual with capital to loan or invest. Such a happenstance would nonetheless make it a good investment relative to most alternatives.

Whether one takes the September 8 price at which I mentioned silver as a hedge against dollar weakness or whether one takes the most recent price (Friday, Sept. 17), silver is, I believe, well-positioned to rise in fiat dollar terms faster than the general rate of price increases people will face in America over the next year or two. Here are some of the reasons I feel this way.

1. Silver has non-mainstream committed sponsorship that has gotten the price trend right. Please consider an on-line article on silver written by Adam Hamilton in 2006 (who currently writes at Please consider reading it in its entirety. Not only do these comments from 4 years ago look wise today, his bullish commentary over the more recent past has been impressive as well (full disclosure: we are totally unaffiliated).

Silver has some highly committed partisans. Some of them argue passionately that there is a cartel that has been manipulating the price of silver down, and that there are massive "short" positions that would cause a tremendous rise in silver's price should these positions have to be covered.

I have no opinion on this controversy. It is, however, helpful to less committed silver bulls to have owners of silver who are not looking simply for another 5-20% appreciation (for example) before they sell. There may be many holders of silver who are looking for much, much higher prices. Thus the more modest aspirations I have for silver prices may allow me to sell with less competition from other sellers.

2. Silver has interesting fundamentals from a supply and demand perspective (click HERE for the Silver Institute's analysis, and scout the entire website if you are interested in all sorts of facts about silver). Above-ground silver stocks are historically low, and silver is primarily produced by miners as a by-product from copper and other mining. Therefore, the pace of silver production does not vary much with the ups and downs of silver's market price. Silver production is relatively price-inelastic.

3. A specific aspect of the supply-demand aspect of silver investing is, in a circular fashion, the investment aspect itself. Not to be mysterious; this refers to the growth of exchange-traded funds (ETFs) that own silver bullion. It was only in 2006 that the first silver ETF, symbol SLV, was created. Then came SIVR. Now there is also Silver Bullion Trust (mostly traded on the Toronto Stock Exchange). Eric Sprott's folks, who came out this year with the hugely successful "PHYS" gold ETF, are in registration with another silver ETF that may come public in a few months.

The more silver ETFs there are, the more silver they will buy. Of the "flavors" of ETFs, Silver Bullion Trust and the upcoming Sprott silver ETF are different from SLV and SIVR, and unlike them, they permanently take silver out of the supply chain and hold it indefinitely, regardless of the price of silver. So the growth of those sorts of funds is more bullish for the supply side of the supply-demand ratio than is the case for SLV and SIVR, which sell silver into the marketplace when demand wanes and thus can exacerbate a bear market in silver (having helped cause the bull market by first having purchased the silver).

A further important factor is that unlike gold, which is very valuable per ounce and is also denser than silver, it is not easy to store significant investment quantities of silver in one's personal possession. It is certainly do-able, depending on one's storage capacity, but those practical difficulties have seriously inhibited silver bulls from taking personal possession of investment silver. This is in sharp contrast to gold. Silver ETFs mitigate that problem and their growth may be even more bullish for silver's price than gold ETF's have been for the price of gold.

4. Silver has been money on and off throughout history and could be money again. In India and many other places, silver is viewed as a permanent store of wealth. It has taken the United States a long time to begin to lose its faith in paper money; in India, the public never trusted paper currency. Thus silver trades as a potential monetary metal in the minds of most of its purchasers in a way that the vastly more valuable platinum or palladium do not. Should the mass media start pushing inflation and not deflation as the problem, silver will come onto the "buy" list of John/Jane Q. Public as a gold substitute, I believe.

5. Silver has important physical-chemical activities that make it medically and industrially useful, and its use in such fields as medicine will continue whether it sells for $10/ounce or $50/ounce.

6. If you are my age, you may remember when the Hunt brothers tried to corner the silver market and briefly pushed the price to $50/ounce or so in early 1980. You also may remember that the metal bounced back to almost $25 in September 1980, related to the onset of the Iran-Iraq war. So in other words, silver at $24/ounce would merely put it below where it was 30 years ago in nominal terms, without inflation adjustment (of course, $25 was very high; silver crashed to near $4/ounce in 2001). Any sophisticated bullish investor who looks, as he or she should, at a very long-term price chart on silver, will be comforted to see that a purchase around now is unthreatening from a long-term perspective. Merely to hit the September 1980 price high, which was free of the manipulation the Hunt Brothers engaged in, would in inflation-adjusted dollars put the price at least at $75/ounce. That's about a quadruple in price. It would take a tax-free 4% zero coupon bond well over 30 years to quadruple in total return. So the truly long-term investor in silver can wait a long, long time for it to outperform bonds while providing portfolio diversification.

From a trading perspective, the proprietary technical indicators I pay attention to are, in general, positive. Silver appears to be in a high-level consolidation below the 2008 high. I am looking to buy more on a dip; my assessment is that the chart suggests enough "potential energy" for silver to ascend well above its current price within the next year.

What follows is a history of silver's recent price action, followed by a detailed discussion of ways to invest in silver.

Silver hit a post-1980 peak in March 2008 at slightly above the current price; but that followed a massive move from a low of $11.67/ounce on 8/21/07 to a high of $20.92 on 3/17/08. That seven-month move saw silver's price almost double. It occurred during the last gasp of the financial bubble but at a time when the lagging effects of several years of Fed tightening (or, diminishing looseness, if you prefer) were slowing the economy. That surge was "too far, too fast". (Data from

The current move in silver has also lasted 7 months. It began with a Feb. 8 low of $15.14. The tightness of this move and the length of time silver has spent in the high teens without triggering profit-taking impresses me.

One year ago, gold also quietly moved up on its 2008 price high, consolidated at a high level below that high, and then burst through it, so far never to revisit that 2008 high. Silver may strangely be mimicking gold one year out of phase.

Income-oriented investors should be aware that both the SLV and SIVR silver ETFs allow shareholders to sell covered calls against their shares. SLV options have far more liquidity than do those of SIVR. Many people may find a "buy-write" strategy attractive. A further discussion of options is beyond the scope of this post.

Readers interested in exploring investing in SLV, by far the most popular way to invest in silver in the United States, may want to read the prospectus. Questions have been raised about SLV's use of derivatives, sub-custodians and other aspects of its structure and operations. I look at SLV as a trading vehicle and a vehicle that allows me to perform options strategies. My silver ETF of choice for longer-term investing is Silver Bullion Trust, which is a Canadian operation and which stores its silver in Canada. It trades on the Toronto stock exchange as SBT.U (SBT_U on some web trading systems) and has a relatively illiquid U. S. "pink sheets" listing with the symbol SVRZF. SBT is run by the same Spicer family that started the Central Fund of Canada (CEF) years ago. CEF is, by the way, the one investment I know that allows one to simultaneously own both gold and silver. CEF is highly liquid and fulfills an interesting market niche by being a combined gold and silver fund.

I have only bought shares in these sorts of ETFs when their premium to net asset value (NAV) has dropped to average or preferably below average. Each ETF tends to have its own premium (or discount) to NAV.

The above discussion is, again, not any sort of recommendation for anyone to purchase any security or sell any option, but perhaps it may stimulate thinking and research.

I have not mentioned stocks of silver producers. I do own stocks of gold miners but not of companies that primarily produce silver. The price of silver is volatile enough for me.

Right now I believe that the intermediate trend for silver as being up, so I'm looking for that volatility to work in favor of the owners of silver.

Regular readers of my blog know that I believe that the American investment world has become "over-financialized", as described by PIMCO's Bill Gross in his November 2009 note. This means that it is my opinion that all financial investments involve trying to choose from the best of an overvalued lot, so that I am not enthusiastic about any choices.

In owning silver, I am choosing something at the other end of the financial spectrum from most investment alternatives that mainstream financial advisers recommend to most people all (or, almost all) of the time. As does gold, investment silver just sits there. There is no promise to repay principal as with a debt instrument. There is no operational risk. In fact, it costs money to store it in the ETF. Most financial advisers will, to my knowledge, point out how speculative precious metals investing is. And of course they have a point. However . . .

I think that it now is the case that lending at today's interest rates is a speculative activity, especially to the U. S. Treasury given the rampant monetary inflation that has already occurred but has simply not shown up in consumer prices (yet).

Not to confuse anyone about bonds: I have written a few weeks ago that I believe that Treasuries have very recently crossed the line into bubble territory. Actually I sold stocks and bought some Treasuries just a couple of trading days ago on the recent yield bounceback associated with the stock rally, because I wanted to speculate that the Treasury bubble will continue. In fact, it is my current assessment that the Treasury bubble is not bursting that leads me to expect yet more inappropriate money-printing by the Fed, and that when that ceases, the financial community will find ways to keep yields low. All of which will tend to be bullish for precious metals as I see it today. (What happens with yields on Treasuries is too political to do other than speculate on.)

As a loyal American, I hope I am all wrong. I hope the Fed is making brilliant, responsible choices. I hope there is a clear plan somewhere in Washington to deal with all the Federal budgetary issues so that no further pressure is placed on the Fed to buy government debt with newly-created "money". I want living standards to rise in a non-inflationary manner. Hope is not an investment strategy, though.

I believe, though, that's its closer to the truth to say that the American monetary fish is rotting from the head down. Simon Johnson's The Quiet Coup provides an expert's view on this topic. I fear that the risks to the dollar are to the downside. I believe that's what Barack Obama, all the Congressional leaders of the Remocrat/Depublican party, and Ben Bernanke all want. And as a loyal American, I want to invest along with their desires.

Since all currencies are now fiat, precious metals help me do so.

In the final part of this series, I will discuss foreign currencies that Americans can invest in both for higher current income than U. S. Treasuries provide and that offer possible appreciation against the dollar.

Copyright (C) Long Lake LLC 2010

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