Don't Sweat Silver's Slide
by Jospeh E Meyer
China’s announcement that it would raise interest rates to curb inflation by 25 basis points to 5.56% has the dollar trading stronger and that’s taken precious metals lower. Silver, of course, has fallen even worse. The iShares Silver Trust (SLV) exchange traded fund was down nearly 3% at the opening bell to $23.26. But investors in this space shouldn’t panic by locking in sales now.
In fact, as silver prices fall in the days ahead, buying the precious metal makes sense so long as investors believe the U.S. Federal Reserve’s quantitative easing 2 program is going to pump nearly a trillion into the market, sending the dollar down, down, down. A weak dollar means strong commodities, and that includes silver in this case.
December silver futures fell to $23.77 from Monday’s close of $24.41 and will likely trade lower through intraday trade. Silver has support at $21.50 and that could be a buy signal once again from traders. I still think silver futures can go to $26 an ounce before the end of the year, especially if QE2 looks like a dollar-kill.
A pullback to $20 in silver is reasonable and probably will be one of the last chances to get on board. A lot of prudent money is coming off the table taking profits. SLV is up 40% year-to-date. The correction in silver will be sharp, but it will be short lived.
Fundamental Support for Silver
The higher gold trades, the more investors will turn to less costly silver as a way to take part in weak dollar/strong gold narrative. Silver-linked stocks are way more volatile than gold-linked stocks, so investors should expect that for every 1% move in gold, silver should move somewhere between 2% and as high as a whopping 6%. For example, over the last five trading days, the iShares Gold (GLD) ETF declined 0.57%. The silver ETF rose 2.4%.
The Main Street retail investor at this point is still not participating in the metal bull. He is invested in bonds and trying to preserve capital, even if inflation is eating up their returns. But when they enter this market, even lightly, metal prices will rise on that demand. Main Street retail investors are still afraid of metals at these levels.
Maybe they shouldn’t be. And here’s why.
If you go back to the last precious metals bull-run in the early 1980s, gold was trading an average of $850 an ounce in the futures market and silver was around $49.25 an ounce. That’s a ratio of around 17 to 1, or 17 ounces of silver is the price equivalent of one ounce of gold. If we were to see a similar ratio to that now, given the weak dollar/commodities bull trade narrative, then silver prices will catch up to gold. Silver is still very undervalued relative to gold and I do believe that moving forward, silver will outperform that precious metal.
Everyone on CNBC and in Bloomberg is talking about QE2 and its impact on the dollar. If QE2 does happen, and it looks like it will, and if we see a trillion dollars pumped into the economy, then there is no doubt in my mind that that policy will set off very high inflationary expectations down the road. Silver is smelling that out. Silver is still very much under-owned.
There is a psychological barrier to silver because it is not as big a monetary metal as gold. The days of silver taking huge corrections and lying dormant are behind us. When we get sell-offs in silver, instead of the price staying down for weeks and months at a time, we stay down for a few days then move to new recovery highs in prices.
Every bull market is different. This market is different. I don’t think Main Street is in on this market and I think they will come in. If you have official inflation at 1.6% and bank CDs paying maybe 1%, maybe 2%, cash preservation becomes impossible in savings and bank CDs.
When you get weakness in silver, add to your position in whatever way you prefer to play the precious metals market.
Silver futures short-term target: $25-$26, then $28-$30 in the medium-term. Then I suspect if the weak dollar/strong commodities narrative continues, then we move above $32 by 2012 as we work out the deleveraging from the 2007-08 credit crisis.
The biggest risk to silver is the same as gold, with the Fed starting to drain money out of the system instead of pumping it in. I believe although this is an important factor it will not by itself derail this massive bull market in the precious metals.