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SILVER ALERTS

UP

DOWN

NO CHANGE

ALERT FLAGS (explain)

Speculative (less than 3 months)

Caution

 

05/15/08

Short Term (3 months to 1 year)

Buy

 

05/15/08

Medium Term (1 to 3 years)

Buy

 

05/15/08

Long Term (more than 3 years)

Buy

 

05/15/08

MARKET INDICATORS

 

 

 

COMEX Open Interest Futures & Options

165,979

 

05/06/08

Ounces Held by Silver ETF SLV

192,569,101

 

05/14/08

Ounces Held by Silver ETF ZKB - SWISS

16,292,710

 

05/09/08

Ounces Held by Silver ETF PHAG - LSE

11,082,610

 

05/13/08

Ounces Held by COMEX Warehouses

133,753,887

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05/14/08

Ounces Held by Central Fund of Canada

41,523,556

 

05/15/08

Ounces Held by Millenneum BullionFund

3,572,034

 

05/15/08

Ounces Daily Clearing Volume LBMA

154,700,000

 

03/31/08

Silver ETF NAV Prem/(Disc) SLV

-2.12%

 

05/13/08

Silver 12-Mo Rel. Interest ("Lease") Rate

0.51%

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05/14/08

Silver Price Basis Daily Cents/Oz. | Ann % (explain)

0.08 | 1.71%

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02/14/08

Gold Price Basis Daily Cents/Oz. | Ann % (explain)

6.15 | 2.47%

 

02/14/08

G/S Price Basis Ratio | Difference

1.44 | 0.76%

 

02/14/08

Silver Futures Spread Cents/Oz. (explain)

Dec'08

Dec'09

Dec'10

Dec'11

  Mar 2008 COMEX Futures | 02/14/08

35

72

113

151

 

TODAY IN SILVER | Archives

MAY 15 2008 2:25PM - Gold moved higher today on the inflation theme and left its buddy silver trailing behind. Yet it is silver that seems to have the better fundamentals at present, what with another 2 million ounces added to the big Barclays iShares ETF yesterday. Perhaps silver's lackluster performance today can be traced to the CFTC's erstwhile attempt to disprove Ted Butler's theories about silver manipulation on the COMEX.

 

The CFTC takes apart most of Mr. Butler's claims about the silver market rather convincingly using logic that appears pretty solid. For example, the CFTC claims to have interviewed 5 of the largest 10 commercial traders in COMEX silver, finding that the commercials have numerous customers on whose behalf they trade that sometimes leaves them net long on the COMEX but typically close to neutral when combined futures contracts, physical positions and OTC derivative positions are taken into account. Of course, the rub is the OTC derivative positions and if there is any truth to Mr. Butler's claims, it lies here. Yet that truth is most likely much smaller than Mr. Butler alleges. In particular, it is the OTC derivatives and not necessarily the COMEX that creates the main risk of default in silver deliveries. Be that as it may, only a few will probably notice that the CFTC actually makes a critical admission that is in total agreement with Mr. Butler and also exceedingly bullish for silver prices: that low silver prices in the past were due to the existence of stockpiles and the recent rise may have been due in part to the exhaustion of such stockpiles. The CFTC does not proceed to reach the natural conclusion that silver prices will continue to rise unless more stockpiles become available or new ones can be built up, but this is understandable considering its job does not include providing investment advice. So, this CFTC study ends up being a very bullish development for silver even though it pretty much puts one of the biggest silver bulls in his place.

 

Speaking of studies, over the next several days I will complete my review of the recent silver surveys released by the various metal consultancies and will post a critique. For now, I will just say that a disagreement about the future prospects of the white wonder metal seems to be emerging.

 

Now for a quick update on silver stocks. I bought another 5,000 shares of U.S. Silver, under 50 cents, in the past 2 weeks. The company recently announced a share buyback of up to 7 million shares, which is not huge compared to the 211 million shares outstanding but it does indicate that the ballooning share count is probably not a big worry going forward. I still view my strategy of U.S. Silver doubling by early December as viable.

 

Then there is Hecla, which released its first quarter results recently and the shares got knocked because earnings did not meet expectations and costs are rising. On the earnings front, the miss was basically due to a delay in shipping a month's worth of concentrates from Greens Creek, so this was really a nonissue. With respect to costs, Hecla made a point that should be of interest to all shareholders who own companies that produce silver in lead and zinc concentrates: apparently lead/zinc smelting costs are about to go much higher like many other aspects of the mining industry and there also appears to be increasing competition for smelting contracts with the possibility that some producers could be left out in the cold (the last part is my speculation, not Hecla's). So, I would suggest that you add another arrow to your "due diligence quiver"--namely, it is now more important than ever to understand the wherewithalls of your silver producers' smelter contracts especially where production is growing from a small profile to a large one.

 

Finally, it looks like Silver Wheaton will keep announcing silver stream deal after deal, the latest with Farallon Resources. This actually has an interesting tie-in with the CFTC study. Some of you may recall that I wrote a piece a few years back about how Silver Wheaton was about to change the silver market because by-product miners typically sold their silver production forward and this was the basis for a significant portion of shorting including the commercial shorting on the COMEX. In fact, the CFTC refers to this being one of the major reasons for commercial shorting on the COMEX. So along comes Silver Wheaton and others like Capstone Silver and Coeur d'Alene Mines and they start to buy up this by-product source of silver. The result is that, little by little, the source of forward selling is diminished and the silver price is no longer pressured by an artificial (paper) supply of silver coming on the market prior to the appearance of real supply in the form physical production from the mines. I thought (and I still do) that such a development would chip away at one of the major constraints to higher silver prices--the propensity to short forward production. And so, Silver Wheaton's ability to still do these types of deals is a very bullish fundamental factor in the silver market, even though I'm the only one who seems to talk about it.

 

MAY 14 2008 2:22PM - The dollar is still deciding what to do next and Wall Street continues to fantasize about the "worst being over". The au/ag moving averages, however, continue to rise with the 200DMA currently residing at $15.50 for silver and $830 for gold. If another bottom still needs to be put in before au/ag advance higher, I don't expect it to be much lower or too far in the future.

 

MAY 7 2008 2:44PM - While the dollar threatens to move higher we cannot be too confident that au/ag have put in bottoms. In addition, oil has risen to a level it may not be able to maintain for long yet that rise has translated to very little assistance to au/ag. The flipside may be that any decline by oil would not hurt au/ag that much, but then again such an outcome won't help either.

 

The speculative shorts in COMEX silver futures according to the latest COT report are down to an incredibly slim 11% whereas commercials hold 73% of short positions and the remainder are "spreads". Unlike Ted Butler, I don't believe spreads are uneconomic: their tiny margins allow them to be used as effective tools to speculate on changes in the basis (contango/backwardation). In fact, this is an area of I've been looking at very carefully lately, although I haven't made any moves yet. In any case, the current COT structure in silver is very unusual and it portends some potential fireworks ahead. Mr. Butler claims one possibility is that commercial shorts are unable to liquidate their positions further and therefore this could mark the beginning of a "big move up shortly".

 

MAY 2 2008 12:36PM - The latest big news ignored by the "don't worry, be happy" crowd on Wall Street is the Fed's increase in the Term Auction Facility from $100 billion to $150 billion along with the easing of collateral restrictions under the Term Securities Lending Facility. Now, AAA-rated asset-backed securities of all types can be pledged, not just mortgage-backed securities. What this means is that credit deterioration and liquidity problems continue to spread outside the mortgage sector.

 

The other big news today was the addition of 4 million ounces to the Barclays' iShares silver ETF, which is now closing in on 200 million ounces. This should make it clear to everyone paying attention that: (1) investors will buy physical silver when the price is rising; (2) investors will buy physical silver when the price is falling; and (3) investors will not sell physical silver during price spikes. Perhaps this is why silver had a nice rise today.

 

MAY 1 2008 3:05PM - It took about 5 hours for my latest silly technical analysis to be invalidated, which is a good thing because there really wasn't any time to act on it. Unfortunately, the present au/ag dip indicates further declines are likely. In particular, a breach of the $16 level in silver (it has not happened yet) portends a quick drop to $15. But cheer up, there is some good news here. First, silver is now within $1 of its 200 day moving average and is thus presumably getting close to a bottom. Second, the recent new bloom may wear of the U.S. dollar and economy rather quickly. Today, stocks soared on the news that consumer spending rose last month despite the fact the rise was due almost entirely to price inflation. Delusional is an understatement. Third, investment holdings by silver ETFs and funds continue to be steady in the face of steep unrealized losses. Fourth, the FED's balance sheet still looks bad with $283.8 billion of reserves at risk (although down somewhat from last week). Fifth, au/ag's vulnerability to a substantial decline in oil and commodities has been decreasing. Sixth, COMEX open interest in silver has plummeted to normal levels and gold is also down substantially from the highs. All in all, I believe the above factors point to a solid au/ag buying opportunity ahead, if not here and now.

 

Here is an interesting point. A friend suggests the recent stellar performance by bullion did not translate to PM shares, especially the juniors, because the buyers in 2007-2008 were not the same as those who drove the market in 2005-2006. Namely, the 2005-2006 buyers consisted in large part of individual investors in the U.S., Canada, Germany, etc. who split their funds somewhat democratically between physical metal and shares. These individual investors were attracted to the junior market and threw substantial amounts of money at it, causing it to soar. By contrast, the 2007-2008 buyers were mostly institutional investors looking for diversification or direct exposure to commodities. They piled into index funds and au/ag futures, causing open interest to explode. They also bought some of the large resource stocks, which is why the HUI and XAU have done relatively well, but they largely ignored the junior market.

 

He had another pretty good point, which is that some mining share booms such as the one in 1995-97 were predicated on new discoveries and not necessarily higher metal prices. Indeed, relatively low metal prices have the effect of keeping most marginally-economic projects in check and thus the number of companies vying for investors' attention is reduced. That allows the true gems to really shine and creates the opportunity for substantial price appreciation across a swath of quality companies. This is only natural since there is a finite number of quality projects. Compare that to today when the majority of "new" projects are really just old projects that were not economic at lower metal prices. This means that, ironically, higher metal prices can actually obscure the true value of worthy projects. Another takeaway is that investors should be weary of projects whose value is predicated on high metal prices. This doesn't mean such projects should be shunned, but instead investors might do well to understand the risk and balance it with companies whose projects would be profitable even at marginal metal prices. In effect, low cost producers are safer as investments while high cost producers have better prospects as speculations.

 

At the start of this bull market, the marginal price for silver was roughly $5 and for gold it was $300. Today, those numbers could arguably be increased to $8 and $500. Among companies that produce silver, three juniors jump out as easily profitable even at marginal prices: Silvercorp, Excellon and Fortuna Silver. There are others as well but these are the three I've had a chance to analyze recently and would have few qualms buying (although I don't presently own any shares). Among the seniors, Hecla, Pan American and Silver Wheaton would also be profitable at marginal metal prices. I've been buying Hecla for unrelated reasons but perhaps I'll buy more of it based on this investment thesis. 

 

APRIL 30 2008 11:00PM - The Fed did nothing surprising today but it appears that au/ag were prepared for the worst judging by their relief rallies after hours. The monetary metals have not, however, escaped the gravitational pull of weak sentiment nor have they repaired the recent technical damage. Silver will need to trade above $19 and gold above $950 for that to happen. Fortunately, we don't need to wait until then to establish long positions from a speculative perspective. You see, the July 2008 COMEX silver contract never quite got down today to the $16.42 level that it hit on April 1. There is some significance to this because the $16.40 level marks the bottom of the uptrend line starting on August 17 at $11.55 and touching $13.975 on December 17. Moreover, a similar pattern in 2006 was resolved in a rather bullish manner. Click following chart for a better view.

 

 

I admit this is pretty silly even for technical analysis, but it does give us a pretty good place to put a stop. Namely, just below $16.42 basis July 2008 COMEX. At the moment, the price is right around $17.00 so there is a bit of downside exposure, but not too bad. Should we get another pullback, the setup would get even better because the stop would be tighter. Now here is the real interesting thing though. Note the trend line was kissed about 6 weeks after the 2006 high was put in, and that was the absolute low of the move. That low has not been threatened since, not even by the August 2007 washout. Today, it is also about 6 weeks past the 2007 top (so far) and the trend line has just been kissed as well.

 

Okay, enough chart voodoo, it's time to move on to mining voodoo. On April 22, I had this to say about Crystallex: "It can't get much worse for the company unless the project is simply taken away." Well, that's pretty much what appears to have happened today as a Chavez bureaucrat denied the final environmental permit for Las Cristinas. The denial was based on a subjective, simple decision--one that could have been made years ago, sparing Crystallex shareholders the endless agony and pain and saving the company hundreds of millions in expenditures. 

 

Meanwhile, Aurelian has announced a layoff of 300 local employees at its Fruta del Norte project in Ecuador as a result of that country's amateur experiment with revising mining laws. At least in this case no additional money will get spent on a project that could be destined for nowhere.

 

No wonder the PM stocks are in such a state of malaise: the wet blankets just keep coming and coming and coming. Novagold at Galore Creek, Northern Dynasty at Pebble, Gabriel Resources at Rosia Montana, plus the aforementioned Aurelian and Crystallex are all 10+ million ounce world-class gold deposits that may never produce a single ounce of gold. Perhaps this is what Barrick management was thinking when they announced Peak Gold last year.

 

Okay, enough griping. I'd like to briefly update the U.S. Silver situation. The company put out some pretty bad fourth quarter 2007 numbers yesterday which tend to show the tough and long road that still lies ahead before the turnaround can be called a success. The first quarter of 2008 is not looking significantly better and so shareholders will now have to wait 4 months for some possible good news (when second quarter results will be released). This represents yet another reigning in of already low expectations and some frustrated shareholders took the opportunity to throw in the towel today. As a result, the shares traded as low as 41 cents Canadian on big volume of almost 8 million shares. Buying at these prices were those investors who've peeked between the lines and found some reasons for hope. Some of these reasons could include: (1) operations appear to have bottomed out during the third and fourth quarter of 2007; (2) if possible to achieve historical head grades again, operations would be very profitable even at current low production levels; and (3) management may have finally lowered the bar enough to jump over it with ease. With respect to my previously-outlined strategy, nothing has really changed given that the success (or lack thereof) of any turnaround should still become apparent during the third quarter of this year. The only thing different now is the financial results were bad enough that the share price could see pressure for some time. For me, this means an opportunity to acquire shares cheaper and for longer, and that's exactly what I intend to do -- carefully. I will mention each time I add to my position in order to help develop this important concept of "carefully" when it comes to speculation. So far, I have 5,000 shares at 61 cents and 5,000 shares at 55 cents.

 

I'm going to wrap up today on a more positive note. My favorite gold porphyry hunter, Exeter, just announced a phenomenal drill intercept at Caspiche in Chile consisting of 719 meters of 1 gram per tonne gold and 0.38% copper. This hole confirms the world-class potential of this project and the main question now is whether it is merely large (10 million ounces) or humongous (20 million ounces). I'm not exaggerating much when I say this is a billion dollar hole. It puts to shame everything that competitors Serengeti and Southern Arc have done and easily bests Canplats' impressive Camino Rojo work. Yet apparently the market didn't seem to notice (or agree) given that Exeter was up less than 10% on tepid volume. Regardless, it's only a matter of time before PM investors start to realize this is a must-own gold explorer. I have removed all stop losses from my positions and will instead aggressively accumulate for my long-term speculative portfolio on any weakness. It will probably take some time for Exeter to fully blossom but I'm fairly certain that it will trade at $10 in the next couple of years and maybe sooner. I base this on the observation that MAG Silver, a joint venture partner with Penoles in certain concessions at Fresnillo, Mexico, has a similar share capitalization as Exeter yet it is trading at $12. This based on drill results not much better than what Exeter has been doing at its Cerro Moro project in Argentina. On this basis, Exeter's $4 share price is more than justified by Cerro Moro alone, which means that you are getting the 719 meters of 1 gram per tonne gold and 0.38% copper for free. If you like giveaways, here is one for a billion dollars.

 

APRIL 29 2008 2:00PM - It doesn't look good here as both gold and silver failed to maintain support today with the Fed meeting underway. Oil appears ready to take a rest, the dollar continues to threaten a rally above 73 basis the index and investor mentality is getting more and more mental. By "mental" I mean oblivious to the nasty economic conditions that appear to lie ahead.

 

How quickly the fortunes of monetary metals can change! Just a couple of weeks ago the problems seemed so severe that only a fool could say that the end was in sight. Yet tomorrow there is a reasonable chance the Fed could signal--and stoke the misconception--that the worst is over by not cutting rates or by cutting 25 basis points while signaling that rate cuts are coming to an end. In the short term, a shift in investor sentiment toward complacency could very easily clobber the vulnerable resource sector along with au/ag. The vulnerability is on account of potential hot money outflows as speculators flee for the hills. The failure of support at $890 gold and $16.70 silver is very worrisome in this regard as it portends a sharp move lower at least to the 200 day moving average currently around $825 for gold and $15.25 for silver. A severe drop could even breach these levels and result in a decline to perhaps $750 and $14.00.

 

On the other hand, I'm not convinced the Fed actually cares a whiff about inflation given the persistent and very real threat of an economic disaster. After all, home prices are still falling, loan defaults are still rising, consumer confidence is still sinking and spending is still shrinking. The liquidity crisis at the banks may have been temporarily forestalled, but the liquidity crises facing consumers and businesses appear ready to spin out of control. Unfortunately, there are no easy, practical solutions for such crises but there are plenty of impractical approaches, such as the tax rebate checks going out in the mail this week. Too bad this type of economic stimulus will be about as effective as peeing into an inferno.

 

There should be little doubt that other, more meaningful yet no less impractical approaches will be tried in the future. They too will fail. Meanwhile, the practical solutions don't seem very practical and that makes them very difficult and unpopular: (1) encourage a substantial rise in labor costs and general price levels in order to eat away at relative debt levels; (2) return to the gold standard; (3) endure monetary collapse and start over with yet another fiat standard; etc. These scenarios are all bullish for au/ag prices. In fact, I can't really think of a practical solution that would be bearish.

 

While the above are longer term considerations, even the gloomy short-term picture has some rays of hope for au/ag. For example, the growing au/ag pessimism may be a sign that the worst is actually over and any further declines, even if sharp and painful, could be over very quickly. It is also possible that the imminent Fed action/inaction could be interpreted as bearish for the dollar, at least by its foreign holders. Furthermore, any Fed validation or legitimization of concerns about inflation would be bullish for au/ag regardless of the dollar's reaction. It's a long shot but one potential outcome is a disconnect in which the dollar rallies moderately while au/ag prices explode. Even if, however, none of these things come to pass, it is entirely possible that the Fed action has already been discounted by the markets. That could mute any dollar or au/ag reaction and might even reinforce the dominant trend (dollar down, au/ag up). In summary, the risks are significantly less acute than they would be if gold was still trading above $1000 and silver above $20.

 

Be that as it may, the rays of hope for PM stocks seem to have completely faded away as the share prices keep getting clobbered day after day amid steady selling and pessimism. It's hard to imagine how some of these prices can possibly go lower but yet they keep going lower regardless. We are already at levels in many stocks that are below their lows of last August and yet the final washout may still lie ahead.

 

Hopefully many of you who have been buying in the past few weeks and months are doing so carefully and therefore still have some funds left to scoop up the current and future bargains out there. Right now, you can find good values by asking a blindfolded monkey to throw darts. Some of the recent companies I've discussed, such as Hecla, U.S. Silver and First Majestic, are approaching valuations that are more appropriate for banks and utilities. Personally, I will be making some careful additions to my position in these and other companies in the days, weeks and months ahead. If the au/ag bull market is not over (a 99% chance), then the current situation represents one of the best buying opportunities in PM stocks ever.

 

APRIL 25 2008 2:30PM - One foot went over the edge of the cliff this morning but the other foot wouldn't follow, so we'll have to wait until next week to see the au/ag drama play out. One negative in gold is the recent reduction of gold holdings by the GLD ETF to the tune of 1.6 million ounces. On the other hand, the silver ETFs are holding steady even if they are not adding.

 

Speaking of adding, I bought another 5,000 shares of U.S. Silver today at 55 cents. The shares have now reached an all-time low and this is a bit disconcerting given the imminent release of presumably positive 4th quarter financial results. Until I see those, I'm not going to buy anymore as 10,000 shares is more than enough of a risk on what could turn out to be a punt. I also bought a small position in Hecla today as I expect it to double from current levels (more on that later). I will be adding to this starter position on weakness. Finally, my "stink bid" in Oremex has not been filled yet but I am still looking to augment my First Majestic position with this small gamble on a share-for-share basis.

 

A quick roundup of some other stocks. After exiting Southern Arc and Serengeti positions a few weeks ago I don't see much price impetus in the immediate future. Southern Arc may have some good drill results in a few weeks and I'll watch for those, but for now my focus has actually shifted to another stock, Canplats, that I've recently mentioned. The price of this one has finally started to come back down yet its Camino Rojo project near Penasquito in Mexico remains fairly exciting. I have not bought shares but I'm looking into it. I'm also mulling over Exeter near $4 as it seems to have found its legs and a slew of drill holes from its Caspiche discovery in Chile should be announced soon. Finally, I'm an observer of Silver Quest, a stock that has done particularly well in the past few days. The company has recently had to raise money at a lower price than it would like which has caused some dilution, but the financing was supposedly oversubscribed and the stock has been on a minor tear since then. The latest news out of this junior microcap silver explorer is the appointment of Exeter man Michael McPhie to its Board of Directors. The one thing I'll point out is that today's impressive price move was made on very little volume so there is probably going to be some retracement, but this might be one to keep an eye on especially if it falls back toward the 20 cent level.

 

APRIL 24 2008 11:00PM - I've noticed that many of the au/ag bulls are expecting the correction to continue, which could be a pretty good indication that it might be just about over. Prices still hover at the edge of a cliff but until that last step is taken, there is always the chance for salvation. One interesting development I've been watching over the past couple of days is the divergence of prices in different spot markets as if traders are marching to the beat of their own drums. This could mean there is aggressive buying in some markets and aggressive selling in others. If so, it could be good news in that the current downtrend may not have much coherence behind it.

 

I'd be tempted to make a moderate physical purchase here (if I didn't already have my fill) considering the current silver price and the growing availability of bullion. Some dealers like Tulving are now sitting on a bit of inventory as purchases have slowed down in the past few weeks. I note that Tulving has recently reduced its minimum silver order to 300 ounces so you no longer have to be a millionaire to buy in bulk. I'd certainly keep some dough in case the correction does continue, but tactically this represents a pretty good point to average in a purchase. We are, after all, $5 off the recent highs. The equivalent in oil would be under $90 per barrel, which seems worlds away.

 

Despite all the negativity, there are several short-term reasons to remain bullish on au/ag. One of the biggest is this business about rice shortages, which is putting our mass psychology on display. Riots, panic, hoarding, withholding. All the qualities that we should expect to see in monetary metals at some point down the line! To a minor extent, we've actually already seen a bit of this in the retail silver market. And let's not forget the near-failures of Northern Rock and Bear Stearns, which have brought the fear of financial panic forward from the back reaches of our minds. Food shortages certainly feed into this mentality. And according to the Economist, this is one trend that may be here to stay. Not to mention that the new status of commodities as an investment class are bound to make the situation even more extreme. What I'm saying is we could be in for one torrid hot summer where "sell in May and go away" could turn out to be a disastrous investment decision.

 

As I was reading that Economist article, something occurred to me that I wanted to throw out as fodder. It was during 1972-74 that we had the industrialized world's first major "food shock" along with the better-known "oil shock". The mess in oil was the result of the 1973-74 Arab Oil Embargo, which was punishment for U.S. aid to Israel during the Yom Kippur War. My guess is that today there is a "silent embargo" to punish the U.S. for its invasion of Iraq. Moreover, the rise in early 1970's food prices also appears to have been caused by similar factors that are in play today. The first one is the relationship between food and energy (back then it was because both were key components of production and consumption, today because ethanol made from foodstuff is used as a substitute for oil). A second similarity is new demand driven by the rise in the incomes of large segments of the world's population (back then it was the U.S, Europe, Japan, etc., and today it is China, India, Brazil, Russia, etc.) In 1973, there too was much talk about reaching global production peaks and not having enough food to feed, clothe and power the world, just as there is today. Finally, of course, there is the similar rise in mistrust of governments and their fiat monetary systems during both periods.

 

There are some interesting implications here.

 

First, food and commodities quickly topped out by 1974-75 on an inflation-adjusted basis and after more than 30 years they are only now approaching their real 1974 levels. By contrast, au/ag rose multiple-fold after a serious correction in 1975-76 to peaks in 1980 that we are nowhere near today in real terms, especially in the case of silver. Could it be that we are merely in the first innings of this au/ag bull market instead of the second or even third stage as some pundits claim? Possibly, given that we are just now having our first food and oil shocks of this bull market.

 

Second, I note a similar performance of PM stocks today compared to what took place in 1974-76. This chart provides a good reference point. Note the choppy action for almost 2 years, which is comparable to the price action we've had since June 2006. Note also that gold stocks were making highs as the Dow crashed and that they remained strong for almost a year after gold put in a top. This lagging out-performance of bullion by stocks was even more pronounced at the end of the bull market in 1980. So perhaps we shouldn't be so confused by the tepid performance of gold stocks these days; it could very well mean the best still lies ahead.

 

Third, widespread price inflation (as measured by core and non-core CPI and PPI) did not become entrenched during the 1970's until after the initial oil and food shocks of 1972-74 had actually started to subside. Similarly, price inflation (should it be on its way) this time around could also have a lag effect with the entrenchment coming perhaps in 2009 or 2010.

 

Fourth, this time we may not get a severe spike in commodities with a subsequent bust as occurred in the mid-1970's but perhaps rather a spike followed by stable, elevated prices. Eventually, labor costs would have to be adjusted to match this new reality (for one, so workers don't starve) in spite of globalization and this would increase the price of manufactured goods, creating a feedback mechanism that in turn pushes commodity prices higher. This is precisely what happened in the late 1970's on the national scale. This time around, it would be global.

 

Fifth, the large amount of fund flows into the commodity sector may have an unpredictable and dramatic effect on prices in both directions, but for reasons I've tried to explain before, the direct impact on supply and demand may actually weaken over time. By comparison, investment considerations were largely non-existent during the 1970's. One possible reason for a declining impact going forward include the growing popularity of short or reverse Exchange Traded Notes which would allow the Commodity Index Traders to offset long index positions on paper without the need for futures. In addition, government policies at some point will probably discourage or restrict organized commodity speculation. Yet eventually, high and stable prices may encourage commercials to hedge an increasing percentage of future production, which would allow the free market to alleviate investment pressure.

 

So to wrap things up, here is one possible scenario using the 1970's experience and the Economist playbook. Commodity prices rise during 2008 and reach a peak at some point, then fall back moderately but remain at elevated levels as a result of factors such as ethanol and continued prosperity in emerging economies. Au/ag peak possibly around the same time and then also proceed to correct until the first whiff of price entrenchment, which may come hard and fast on the heels of the commodity peak. In the meantime, gold stocks remain resilient and start to outperform bullion. As price inflation heats up, it feeds directly back into commodity prices. Commodities become proxies for price inflation but au/ag, for a myriad of reasons, outperform oil, food, base metals, etc. as was the case at the beginning of the bull market. At some point the monetary system collapses or fantastic solutions are found for all the big financial problems, and then it will no longer be worthwhile to own au/ag for speculative or investment purposes. Don't get too excited, it's only a theory.

 

One last thing. The Economist article makes a point that countries with large agrarian sectors such as India are net beneficiaries in a world where food is "cheap no more". This could be an important point because Indian farmers have historically been big buyers of au/ag and may continue to be big buyers as prices rise much higher. Like I said, rice shortages could turn out to be very bullish for gold.

 

APRIL 24 2008 2:35PM - Still clinging to the bottom of their support zones as I type this, au/ag struggled all day to keep it together as the dollar threatened a rally. It will be interesting to see how the Asian markets respond to these prices later tonight, although investors there might be too busy buying rice to care much about the monetary metals. The rice shortage is now making worldwide headlines and it looks to get worse before it gets better: Brazil, for no apparent/good reason, has just suspended exports.

 

The dollar rose the last couple of days partly because a chink in the armor of the European economy is becoming apparent while investors in the U.S. are starting to think the worst is over. For example, the German economy is showing early signs of trouble as German business confidence dropped more than expected last month. Second, Credit Suisse has just reported a first quarter loss on account of a $5 billion write-down. Meanwhile, U.S. investors celebrated a tiny profit out of struggling Ford, a small decline in unemployment claims and murky data on durable goods. Little shrift was given to another horrible report on new home sales. All in all, the market remains "cuckoo for Cocoa Puffs".

 

In my opinion, the most important--and relevant for au/ag--news continues to be the Fed's balance sheet, which has deteriorated once more. As of yesterday, a total of $304 billion of monetary base was at risk which represents 39% of the $777 billion of Federal Reserve Notes outstanding. How long will this continue? Well, the amount at risk has increased progressively each week to the point that it may have resulted in sufficient (for now) liquidity injections into the credit system. $304 billion is a lot of moolah and it is still probably sloshing around. As a result, we could see some stabilization at this point. This in turn might even allow the Fed to repurchase some of its Treasury security holdings just in time to bring Treasury yields back down. Yet I expect things will get worse down the road as long as the housing mess continues to fester, which it will until inventory is reduced and banks start to lend again.

 

APRIL 23 2008 1:00PM - Au/ag back down to the bottom of their ranges even with oil at record highs and the dollar within spitting distance of a record low. This is very troubling because au/ag should be shining at this moment. If oil and the dollar are nearing the end of their moves in the short term, it's pretty much guaranteed the current levels in au/ag won't hold and they are headed back to their 200 day moving averages. PM stocks are getting hammered today in recognition of this possibility. It seems they just can't catch a break. Meanwhile, bullion buyers are holding their collective breaths as evidenced by the major ETFs being stuck at the same level of holdings.

 

The positive side to all of this if you like to speculative with options is that the July puts are still pretty cheap--for example the July '08 $15 for under $1,500--while the calls are starting to approach bargain territory (possibly for good reasons). If the current levels hold, there is still the chance to make another run at the March highs but it will need to happen before the end of June. That makes the July call options an appropriate bet, although it is very risky to buy them before we know the $16.70-17.00 support will hold or not. If I were to buy, I'd probably buy the $20 calls in pairs, selling one on a rise back toward $18 to pay for the other. Of course, the safest bet right now is to have some money available for future bargains in bullion and stocks instead of blowing it on restless speculation.

 

Here is one reason why we might be seeing this pathetic weakness in au/ag. It's quite self-explanatory:

 

Strong euro prompts manufacturers' threat

GENEVA, Switzerland, Apr 22, 2008 (UPI via COMTEX) --

The weakening dollar has forced major European manufacturers to consider moving production to dollar-based economies, an industry coalition said. On Monday, the AeroSpace and Defense Industry Association warned of "massive relocation of aerospace production capabilities to U.S. dollar priced locations, where labor costs are approximately 30 to 40 percent lower than in the euro zone," The New York Times reported. As a sign of the shifting currency values, European Aeronautic, Defense and Space company Airbus is raising prices of the super jumbo A380 plane by $4 million, the Times reported. EADS also announced Tuesday it would purchase a California security systems company, PlantCMI for $350 million, in part to strengthen its presence in a dollar-based economy.

 

The above, though anecdotal, is good ammunition to use next time you hear some pundit saying the dollar is toast and will imminently collapse.

 

APRIL 22 2008 9:00AM - Silver showed its ugly side yesterday by sliding another 3% as gold struggled to stay even despite weakness from the dollar and record oil prices. We have at least a partial explanation for the strange happenings late last week in "lease" rates, basis and spreads with the revelation that banks have been under pressure to underreport LIBOR in order to lower their own short-term borrowing costs. My quick examination of the facts and circumstances indicates that there might in fact have been a certain amount of underreporting. In particular, LIBOR in the past few weeks and months appears to have been, at times, anywhere between 5 and 25 basis points (0.05% to 0.25%) below where it might otherwise have been expected. On average, it appears to have been about 10 basis points lower. This is much less than the 30 basis points some experts have alleged, but there is another issue that could even be more important. It seems that LIBOR tends to get "sticky" when it should be rising, as if the banks are trying to influence market rates by trying to put a break on them via the self-reported LIBOR. Each time it becomes clear to the banks that the ploy won't work or the rate differentials simply get too big, the banks appear to snap LIBOR back in a swift move that closes the gap within a day or two. This is precisely what seems to have happened late last week. The "catchup" appears to have been even more fervent than usual due to the widespread publicity about the underreporting, which may have resulted in an additional 10 basis point rise in LIBOR above and beyond what was required to restore parity with the market. Apparently, all the banks have been told to stop whatever they may or may not be doing. The net result of all this is last week's increase in the futures spread and basis may have been anomalies that should be ignored like all the other noise.

 

Where does yesterday's drop in silver leave us? Well, still above the important $16.70-17.00 level but basically back within a trading range. Silver will now probably need to fight its way all the way to $19 before we can confirm another breakout. The good news is that all this time the 200 day moving average has been climbing and recently crossed $15, which is a mere $2 and change below current levels. That means it might be getting close again to when it is safe to accumulate au/ag. Lo and behold, the bullion dealers seem to have found some inventory just in time! Be that as it may, I'd continue to be slow and careful for now.

 

On the other hand, it might only be a matter of time before the dealers run out of silver again. First, however, the grocery stores might run out of rice! There are people apparently stockpiling rice here in Silicon Valley if the story is to be believed. I haven't seen it personally and curiously it hasn't made the local media, but I'm sure it will if the phenomenon spreads. There is a major risk to au/ag here in that government attempts to cool down food and commodity prices could be targeted at the monetary metals, or else they might be collateral damage. Already there are threats out of the European Central Bank that there could be coordinated intervention to stop the dollar's slide as well as give the commodity markets a cold shower. Presumably such cold shower would come from the policy side, such as higher taxes on commodity gains, position limits or restrictions on the size of investment vehicles.

 

Speaking of cold showers, the resource market got another big one late last week as the silly government of Ecuador has passed a "mandate" that freezes all exploration and development work for up to 6 months while a new mining law is drafted. The mandate also strips most companies of the majority of their land holdings, potentially bans open pit mining, and significantly increases the odds that a project can be denied on arbitrary environmental grounds. In effect, this mandate has killed mineral exploration in Ecuador for the foreseeable future. The share price of Aurelian, which hopes to develop the Fruta Del Norte deposit hosting at least 13 million ounces of high grade gold, has cratered along with other companies that have projects in the equatorial country. I believe this latest setback to the mining industry will also have a negative impact on companies that don't have projects in Ecuador as it again reminds investors of the significant political risks borne by international mining outfits. I expect companies with projects in other politically risky regions will be hit the hardest although there is one company that might be somewhat immune. That company is Crystallex, the operator of the Las Cristinas project in Venezuela. It is a single permit issuance away from starting construction on its 17 million ounce gold mine (and has been for almost a year). Unfortunately, the economics of this world-class gold mine depend very heavily on Hugo Chavez's mood from day to day as well as the foreign exchange regime of Venezuela, which has been subject to artificial controls for 5 years now. Without fully understanding the implications of exchange rates, it would be foolish to consider Crystallex as an investment although it might be a worthwhile speculation on the basis of imminent permit issuance. It can't get much worse for the company unless the project is simply taken away. Along with Apex Silver's San Cristobal, at least 3 top world-class projects have now essentially been ruined by South American madmen.

 

APRIL 18 2008 4:30PM - In typically frustrating fashion, silver gave back all of its hard-fought gains of the week by the time the COMEX opened this morning. It seems that finicky traders in London sold the monetary metals with abandon as the dollar index rose above 72 and the Euro cooled off a bit.

 

Oil remained strong, however, as did several other commodities. Stocks in general are also rallying today based on Google earnings that assign a forward P/E of 45 to the Internet darling's shares as well as the news that losses at Citibank were bad, but not as bad as expected. This of course is demented logic and so it comes as little surprise to me that gold and silver (shorthand from now on: au/ag) should suffer on a day when talk of a rise in bond prices on account of inflation fears is starting to dominate the financial media.

 

In any case, this market nonsense is ignoring the latest deterioration of the Fed's balance sheet, wherein $286 billion of backing for the Federal Reserve Note has now been placed at risk. This represents 37% of the U.S. monetary base and essentially means the dollar is facing the most precarious situation of its almost-centennial existence. Yet it is probably still too early to question the survival of the world's reserve currency given that rising bond yields increase the Fed's ability to print and drop money from helicopters. Many commentators claim that the Fed has already been doing this, but the truth is that the Fed has done zilch to directly increase the money supply since the beginning of the crisis. You see, the only means for the Fed to increase the money supply is to issue Federal Reserve Notes (FRNs). The rest is the responsibility of banks and financial institutions through the process of fractional reserve lending. To wit, FRNs in circulation stood at $775.789 billion on August 15, 2007 and today they stand at $777.511 billion. Moreover, this number has been roughly the same since late 2006.

 

So, basically here is what might happen. If bond rates keep rising while credit conditions resume their drop into a bottomless pit, the Fed will be able to take advantage of "good helicopter-flying weather". Aggressive Fed buying of bonds will then lower the long end of the yield curve while flooding the system with fiat money. Under these conditions, the dollar could be expected to make another steep decline, perhaps all the way down to the 52 level discussed in my March 18 commentary. Look, I'm not saying the Fed is willing to do this, but at some point the danger of waiting longer may start to exceed the danger of flying the helicopter. Despite all the huff, Bernanke likely understands that printing money has got to be the last resort, and he probably looks forward to taking the credit for doing so at exactly the right time. That means when it finally happens, it will be quick and out of nowhere. You want to own some au/ag in advance because it will be difficult and very expensive to obtain afterwards. In fact, you should be planning to sell (some) in the aftermath of a true helicopter drop.

 

The above essentially means that rising bond yields are very positive for the au/ag price assuming that the credit markets will continue to depend on massive central bank intervention to avoid collapse. Conversely, newfound stability in the credit markets and improvements in the Fed's balance sheet will signal a reduction in the urgency to own au/ag. We are talking about intermediate trends here that can influence prices over the course of months and years, not day to day fluctuations.

 

Okay, enough monetary B/S, I'd like to move on to some nuts and bolts. Or is it soup to nuts? Specifically, I would like to talk about a couple of silver producers that reported very good financial results yesterday. The first is First Majestic, one of my subjective favorite silver stocks, which has recently started to publicly emphasize its goal to become a senior silver producer. The latest operating results represent a solid step in that direction. Highlights include 3.1 million ounces of silver produced in 2007 (3.5 million ounces of silver equivalents, expected to grow to 5.5 million in 2008) and C$15.9 million in mine operating income excluding non-cash charges. With C$50 million in the bank and a fully-diluted market cap of C$375 million, this is pretty good but the valuation clearly relies on expansion of production in the future.

 

So far so good, but listen to this. The company raised over C$45 million in an offering last month, something that was not necessary if the plan were to simply continue developing its 3 existing mines. Its Chalchihuites or other projects certainly aren't ready for that kind of exploration money, either, which brings up the possibility that First Majestic is once again on the hunt for major property (or small company) acquisitions. Unfortunately, there aren't many properties remaining in Mexico so First Majestic will probably have to bite the bullet and by some company kit and kaboodle. Fortunately, this is something First Majestic's president Keith Neumeyer seems competent and comfortable doing, given his diverse investment, finance and operations background.

 

So, why don't we look around to see if there are any tasty targets that First Majestic could gobble up with its modest C$50 million war chest? Alas, the only one I could find is an unloved, downtrodden little company by the name of Oremex. Provocatively, Oremex has already sold a property to First Majestic during 2006 (in the La Parilla district) and still holds a small concession in the Chalchihuites camp where First Majestic has been poking around in an attempt to consolidate the district. Thus, the two sets of management likely have become well acquainted with each other already. Considering the paltry C$10 million fully-diluted market cap--despite the 50 million ounce inferred silver resource at the Tejamen open pit project--it's no wonder that Oremex recently adopted a shareholder rights plan. You see, if the surface rights negotiation at Tejamen can be concluded soon, the project might produce perhaps 3-4 million ounces of silver starting as early as 2011 or 2012. That production would be almost pure silver with minor gold credits, one of the few in the world this size (similar to Coeur's soon-to-be-shuttered Rochester Mine in Nevada). Given First Majestic's goal of becoming a senior silver producer and its largely unrecognized status as already having among the highest percentage of production from silver (which goes a long way to explain why the company is a subjective favorite of yours truly), Tejamen would fit in pretty well.

 

Now, please don't get me wrong, this is all pure speculation based solely on publicly available information and a bit of brain juice. Also, realize that Oremex is a risky stock as illustrated by the more than 50% decline in share price since I put it on my potential "Ten Bagger" list in late 2006 (does that make it a "Twenty Bagger" now?) But here is something to consider. Why not buy a share of Oremex for each share of First Majestic you buy or already own? That limits the risk in that you won't go crazy buying too much Oremex, and if it goes kaput you can mentally deduct the cost from your hopefully big profits in First Majestic. On the other hand, if Oremex gets bought out for a mere $25 million (not a remote prospect), you've made some respectable dough in a tough market regardless of what happens with the price of First Majestic. And if First Majestic does end up being the acquirer, it might not be a bad idea to roll the Oremex proceeds right back into First Majestic in order to leverage the presumably accretive results.

 

Alright, let me move on to the second "silver" producer (no, Oremex wasn't it). It is Fortuna Silver, and I put the silver in quotes because the silver component of its current operation, Caylloma in Peru, is actually 25% or less as a percentage of revenue. Still, the 2007 results were impressive for the first full year of operations, producing 0.5 million ounces of silver and approx. 10,000 tonnes combined of lead and zinc (roughly 2.5 million ounces total production on a silver equivalent basis). Of course, when silver is such a small component of the product mix, it doesn't make sense to report silver equivalents, and Fortuna management to its credit has refrained from the practice. I note this hasn't stopped some gurus like Jim Dines from picking Fortuna Silver as their top pick for "silver" producers expected to benefit from a near-term rise in the silver price. I'll get back to this in a second, but first I will note that Fortuna generated C$19.0 million in mine operating income excluding non-cash charges during 2007 as falling zinc prices were partially offset by rising lead prices. Fortuna also had around $50 million in cash at year-end (probably higher now) and a fully-diluted market cap of C$225 million as of today. The market cap compares favorably with First Majestic on the basis of mine operating income, and arguably if First Majestic is undervalued then Fortuna is even more so.

 

On the other hand, one possible reason why the market has assigned a fair and square lower value to Fortuna's 2007 operating metrics might be the mix of silver to base metal production: less than 25% silver for Fortuna whereas it's the reverse for First Majestic at more than 75%. Yet the base metal argument becomes less convincing when one realizes that Fortuna's current silver-poor ore mix is the result of a deliberate decision to mine the veins at widths that capture most of the lead-zinc (which is somewhat diffused) but substantially dilute the silver (which tends to occur in discrete bands). Caylloma has veins that are in fact very rich in silver: recent assays include 6,231g/t (around 200 ounces) of silver plus 10% combined lead, zinc and copper over an estimated true width of 1.5 meters. Such bonanza grade material is easily 80% or more silver by value and could be added to the production mix using selective mining methods without huge difficulty, though an increase in cost. If and when there is an improvement in the proportion of silver produced, this should transfer directly to the share price.