Silver Is Probably Overpriced

DoctoRx wrote this piece before this morning’s silver flash crash.

Silver prices are quite vulnerable right now.

Despite being almost 30% off their recent high, they are slightly more than double their price of one year ago, which in turn was nicely up from one year before that. When I last did a post praising the investment qualities of silver, on September 12, 2010, the fund “SLV” was trading around $19.50. SLV is now pushing $36.

More to the point, there are clear signs of froth in the silver community. In that post, I stated:

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.

I did sell most of my silver “too soon”, that’s for certain, though I replaced it with other “hard money”-type assets that also appreciated. I continue to hold some physical and some paper silver, because I do think that it is a more-or-less permanent part of a sound money-oriented investment portfolio.

I grew up in a house with pounds of silver sitting around in the basement, as my father was an inventor in the silver field. To quote him, “Silver is a junk metal”. Silver is mostly produced as a by-product of mining of other metals, such as gold or copper.  Silver has no mystique in my mind.  It has some fine physico-chemical characteristics, but there is plenty of silver in this world.  So long as silver remains a non-monetary metal, the normal pattern of very high silver prices is to encourage substitution to other substances in manufacturing processes.  Thus, silver is very different from gold, which has been generally agreed by central banks and many people across the globe to represent wealth, and which can act as a stable store of value because there are so few industrial uses for gold given the high value it has commanded for centuries as the monetary metal par excellence.

The silver space is replete with allegations of market manipulation, and if some of them are correct, its price could indeed skyrocket soon. However, I am skeptical, because a major paper silver trading vehicle, the Sprott Physical Silver Trust (PSLV), trades at a 17.1% premium to its net asset value. Why anyone would pay that much of a premium for a fund that holds silver, even with a redemption policy into physical for very large holders, is beyond me. I called up a local coin dealer yesterday and was informed that I could buy and sell physical silver at less than a 5% spread between bid and asked. There are no shortages for a retail investor, and the dealer was talking about a substantial $25,000+ cost for a bag of silver. I thus suspect that more likely, the small investor has ended up on the wrong side of a trade involving an asset whose price is too high for a challenging economic environment.

Every day that I look at the futures market and continue to see $100/barrel oil, as is the depressing case again today, the more I anticipate the stereotypical response of the U.S. economy to very high oil prices, which is an economic downturn. Given that silver is basically an industrial metal and is a monetary metal primarily in the minds of its partisans (though it may become one again), we just may find out that there has been a lot of double ordering of silver by its users in order to guarantee supplies. Should business demands unexpectedly blindside those users, watch for a glut and plummeting prices. Silver has no, I repeat no, price stability.

Silver may well be the hard money asset of the decade, as Eric Sprott has stated. It may however do that by first presenting a materially better buy-in price than we see today.

Copyright (C) Long Lake LLC 2011


5 comments to Silver Is Probably Overpriced

  • Keith Weiner

    Docto: I agree there could be more of a correction coming ahead. But I’d like to emphasize a few points:
    1) Like gold, and unlike all other commodities, there is a very high ratio of stocks (inventories) to flows of silver. This, more than anything else, is the indicator of its “moneyness”. The price of a purely industrial commodity crashes if inventories grow even modestly. Silver certainly has decades worth of mine production in inventory.

    2) The conspiracy theorists are smoking something that is not legal to smoke. Naked short selling of futures would press down the bid on said futures (market makers would pull down the offer to keep a spread somewhat stable). One would observe actionable backwardation: the possibility of selling spot on the bid and buying a future at the offer for a profit. This is not currently the case in silver (though silver recently had this condition while prices were rising rapidly a few months ago). It does not make sense to me that while the short selling would have been occurring (to cause backwardation) the price would double, and then while the price falls 25 or 40%, those former short sellers are buying back.

    3) I don’t think the rise in silver’s price was or is due to industrial or jewelry demand. I think it was demand from people who want out of paper plus (especially as the price went parabolic) speculators betting with leverage on rising prices.

    4) What GATA does not seem to be aware of is: arbitrage. It is possible to simultaneously sell spot and buy a future (decarry) or buy spot and sell a future (carry). Since the exchanges and governments don’t know who owns what physical metal, but there are statistics down to the exact number of contracts for futures, people look at the net short position and assume that it is naked.

    5) By the way, it is important to note that if a bank has a receivable for silver to be delivered in December and is short a December future, then it is not naked short. But one could look at its warehouse and see there is no silver. It is perfectly legitimate to borrow and lend (so long as one does not mismatch durations as I describe in my article on Fractional Reserve Banking!)

  • Excellent points, Keith. Let’s see if there’s a summer swoon in silver. Should be interesting to watch. If it occurs, this is one dip I want to buy.

  • Keith Weiner

    As I just commented on Jeff’s article on stagflation, I think the bias of industrial commodities will be downward from here. Though a new larger money printing program could change that (or it could force the 10 year interest rate down to 2%). If commodities get whacked, silver will go down more than gold but perhaps a lot less than say copper or iron. If the money spigots turn on again they may not be able to reignite demand from construction (particularly) or even manufacturers and so copper and its ilk could stay down but there is no limit to how high (in dollar terms) gold and silver could go…

    If not, I would not predict $20 or $25 silver but it would not surprise me.

  • Californio

    I like Morgan Dollars as a hedge against the worst possibly economic event. Junk Silver would be useful in buying small items, Gold would be used for big ticket items. I see no reason to acquire Fine Silver or Paper Silver (SLV).

  • I own junk silver for Californio’s reason. Also own CEF as a way to own paper silver (and gold). It is the lack of any premium on CEF as well as the limited premium for Silver Bullion Trust that makes me skeptical of Sprott’s Silver Fund’s 17% premium and thus I’m skeptical of the silver price should we get months of declining industrial activity globally.

    I have no interest in owning SLV. It just might be a scam as several commentators insist. If anyone thinks it can’t be, please remember what was revealed in 2008.