Silver Investing—The First Big Pullback of 2011 and How to Play It

On April 29th, 2011, the price of silver finally hit a new all time high of almost $50 a troy ounce. Not since early 1980 had the price of silver passed $49 per ounce. The three weeks following the 2011 new high, the intraday price dropped below $32, a 35% pullback. How much more will price drop? Are the analysts who have been saying the price of silver and gold are in a bubble since the price of gold broke $1,000 right? Will the price of gold and silver drop to multi-year lows and stay down for decades as when the 1980 bubble precious metals burst.

I don’t think so.  Consider this: Even if you use the U.S. government’s suspect numbers for inflation, the 1980 peak price of silver was about $112 “2011” dollars.  And today’s U.S. currency issues are much more serious than those of the 1970s. The price of silver was in a bubble in 1980, but we are nowhere near the inflation-adjusted price of 1980.

Regarding the U.S. currency issues, I believe with 99.9% confidence that the worst is yet to come. And that means the best is yet to come for silver investing.

If you have long term silver investments, such as silver bullion or coins, silver mining stocks, or ETFs, don’t worry.  Just hang on.  Likewise, if you own 2013 LEAPS on silver equities or ETFs, hang on.  If you hold a leveraged ETF, such as AGQ, Proshares Ultra silver, you lost big time, 66%, over the course of the 3-week (so far) pullback. I don’t think price is going much lower.

I expect a sharp recovery because physical silver is beginning to be in short supply. But there are charges of manipulation in the futures market circulating again. If correct, that action could keep price down through the summer. Leveraged ETFs are designed for short term trading; days or weeks at best. Slippage occurs in sideways price action. If you still own leveraged silver ETF and price doesn’t recover quickly, you could lose even more. On the other hand, if you sell and there is a sharp recovery, you miss recovering a big part of your paper that resulted from the pullback. I advise holding for the long run. When the price of silver approaches $50 again, place a trailing stop on your leveraged ETF; or a portion of it.

If you own relatively short term call stock options on silver mining stocks or ETFs, you paid a stiff premium, unless you bought a very deep-in-the-money strike price. If you did not buy a very deep-in-the-money strike price, the deterioration in premium over time will kill your profit potential. The only chance of recovering a good portion of the paper loss you have at this point is for a sharp and complete retracement to the $50 price level or above. Sell now.

If you own vertical call spreads, you might buy back the short side of the spread at a big profit whole the price of silver is depressed, thereby offsetting the paper loss you currently have on the option that represents the long side of the spread. That action leaves you with a call option, possibly a short term one. Why wouldn’t my advice above to sell now be appropriate? Because you have recovered much of the loss suffered on your remaining option by buying back the short side of the spread. A quick recovery in price could result in recovering the remaining net paper loss, or even result in a profit.

Another strategy, if you also own gold, is to convert gold assets to silver assets. The gold to silver ratio when both gold and silver were at their all-time highs in April was about 31:1. The price of silver pulled back much more, on a percentage basis, than the price of gold. The current ratio is back up to 43:1. If you believe that the ratio will eventually return the historical ration of 17:1 or lower as I do, now is a great opportunity to shift investment assets from gold to silver.

This deep price pullback is a great silver investing opportunity. The short term silver investing is very tricky. But long term—it’s just a matter of time until silver price explodes.

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