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ARCHIVE: Jan 2007 | 2006

FEBRUARY 28 2007 12:00PM - Out of office, no commentary today.

FEBRUARY 27 2007 9:30AM - Silver and gold weaker today despite a falling dollar as global stock markets drop on fear the world's biggest economies might be slowing. The precious metals stocks are getting a double whacking as they are falling in sympathy with both bullion and the general stock markets. We remain in dangerous territory with the possibility of volatile up and down moves of massive proportions.

In stock news, Oremex -- a stock I have previously placed on an undiscovered silver stock and potential Ten Bagger list -- yesterday reported that the ejidos (land owners) of the Tejamen project have opted now to renew surface access rights, which is always a big risk in Mexico. This has probably been long in coming and is complicated by the fact that part of the deposit (which would be mined by open pit methods) lies under the village of Tejamen itself. Therefore, you don't really want to see an outright opposition to land access when you may have to end up moving a village. Now, it is expected that Oremex will pursue the matter through the Mexican legal system but that can be time consuming, uncertain and costly. I suppose the one positive for Oremex shareholders (if there can be such a thing under the circumstances) is that there wasn't a lot of value assigned by the market to the Tejamen project. That is little consolation, however, if you bought the stock at C$0.70 over the last several days only to see it plunge to a low of C$0.35 for a 50% loss.

This episode is a stark reminder of the risk that mining and exploration stocks represent. From my perspective, what has started out as a long-term value play has now turned into a very long-term value play likely to be resolved through litigation. I wish that I could provide a more nuanced analysis of this and other silver stocks in this forum so as to better present the risks and opportunities, but unfortunately such an exercise would essentially amount to a research report which would require resources and costs that as an individual investor I cannot justify. However, I am looking at some possible solutions to this and will report in the future should I come up with something workable.

FEBRUARY 26 2007 11:00PM - Silver and gold continue their upward momentum.

FEBRUARY 23 2007 2:00PM  - Silver takes off on its march (by March?) to new highs while gold rises moderately, not quite completely free of its restrains. At this point, the precious metals are trading mostly on their own as they take less of a cue from the dollar, crude oil, commodities or what have you. As a result, major volatility in both metals may lie ahead with the possibility of punching out to new highs (and by a wide margin) not out of the question. As for Commercials on The Ropes, that prognostication so far has been incorrect as both gold and silver open interest on the COMEX has continued to grow after slowing down (and in the case of gold, even reversing) in the past few days.

For those who didn't notice, Silverstone Resources has reached an agreement in principal with its spin-off parent Capstone Mining whereby it will acquire all of the by-product silver produced at the Cozamin Mine at a fixed price of $4.00 per ounce in exchange for an up front payment US$20 million in cash and additional consideration of US$24 million in the form of 19.35 million Silverstone Special Warrants (exercisable at a price of CS1.45 per share). Yes Virginia, this is a clone Silver Wheaton deal and one that I had originally heard rumors about at the SF Gold Show. So it seems that the Silver Wheaton model is not dead but may in fact be making a resurgence, even if in a more modest size (the deal is for roughly 10 million ounces of silver). For some reason, this news has not appeared in the usual places and little has been written about it by the gurus. Regardless, it does have implications for the silver market which should not be ignored and for that reason I will cover it in detail even while the so-called experts ignore it.

As far as Silverstone's valuation, is this a good deal for them? Well, at $14.00 silver, the presumed 10 million ounces of silver is costing them $8.40 per ounce ($4.00 deferred price and $4.40 up front -- $44 million divided by 10 million ounces). Thus, there is an undiscounted present value of $5.60 per ounce or US$56 million plus an option value which can be calculated using methods such as Black-Scholes (I will try to do this next week). This compares to a present market cap of roughly US$37 million but a fully diluted market cap (assuming exercise of the existing warrants and options plus the Special Warrants and the private placement to raise the $20 million cash) of roughly US$100 million. The fully diluted market cap should actually be somewhat lower for reasons that I will discuss at a later date (this applies to all stocks, not just Silverstone) and therefore we can see that the undiscounted present value of US$56 million is right in line with the current stock price even when we exclude the Black-Scholes option value. Yet this still leaves at least one factor not quantified, and this is the risk that Cozamin will not produce the projected ounces of silver during the term of the agreement (although this may be mitigated to a degree by the terms of the agreement). For now, I'll just say that Silverstone doesn't appear grossly undervalued or overvalued based on this deal and much of its near term prospects likely depend on the extent to which newsletter advisors and retail investors get excited about the story (something which has not yet happened). Therefore, an investment in Silverstone at this point is probably mostly a speculation that it will be discovered by investors in the coming days and weeks. Next week, I will try to analyze in detail the extent to which Silverstone's share price fairly values the Cozamin deal in order to determine whether or not there is a long-term investment opportunity.

I would like to point out two more things today. First, the recent emergence of a fundamental factor in the gold market -- buying by the central banks of emerging economies even as the central banks of developed economies slow their sale -- has been strengthened by the possibility that a Central Bank buys 20 tonnes of locally mined gold for its reserves. The central bank in question is South Africa and while it remains to be seen whether or not this is actually what happened in this instance, a very bullish trend appears to be in motion. Along with a reduced level of hedging by mining companies (resulting in net de-hedging), the supply-demand balance may be shifting in favor of higher prices even as traditional sources of demand start drying up (as demonstrated by the recent GFMS gold demand figures).

Lastly, I wanted to point to yet another commentary that questions the existence of the U.S. gold reserves, this time going as far as speculating that "Deep Storage Gold" held in the U.S Mint's custody actually means "unmined gold" instead of gold in "deep storage" underground vaults. After a lot of speculation rife with paranoia and logical incongruities, the writer innocently concludes:

"If monetary authorities were really on the ‘up and up’ – they could debunk everything presented here in a N.Y. minute - by simply opening the vaults of Ft. Knox and West Point to a proper, independent, third party audit."

Yet there is one operative concept in this statement that is assumed as fact whereas it is actually the key reason why the argument falls flat: the word "simply". The truth is, there is nothing "simple" about opening the gold vaults to third parties. The reasons for this should be obvious to anyone who understands the security industry or how government bureaucracy actually function. Among the key considerations are: cost vs. benefit (can the government really quantify in terms of dollars and cents its supposedly improved standing with a few conspiracy nuts), logistics (providing security clearances, dealing with constantly changing auditors not to mention the requirement under government auditing standards to rotate between auditing firms every three years, dealing with the Treasury seals on over 90% of the gold, re-assaying and weighing, etc.) and compromise of security (many of the security measures are known by only a few high-clearance individuals but these are measures which may be compromised during a third party audit regardless of the care taken). James Turk himself struggled with the question of "what's the big deal with a third party audit?" after having concluded to his own satisfaction that the gold was being properly audited by the Treasury Dept. and therefore was more than likely still there. The considerations that I outlined above are sufficient to also answer his question. And when I do get around to writing a reply to Doug Gnazzo's Gold Reserve Audit: Part II, I will be sure to address this topic in addition to pointing out Turk's successful mission for the very truth (which he concluded in 2000) that Mr. Gnazzo -- as a deeply skeptical man it seems -- presently still seeks.

FEBRUARY 22 2007 12:00PM  - Despite higher oil prices and a technical breakout, silver and gold were not able to add much to yesterday's impressive rally and both metals are trading down overseas after the NY close.

The Silver ETF added 1 million ounces two days ago despite a low NAV premium which might have been a sign of short covering at that point but then yesterday the NAV premium shot up to 3.50%, indicating a significant demand for silver from ETF investors. I have yet to complete my chart of silver ETF price, volume and NAV premium/discount so I am not able to divine much more meaning from this other than that it is obviously a positive sign. As for short covering, silver futures have not experienced this at the COMEX as open interest continued to increase yesterday, although at a much reduced pace, but gold did see the liquidation of some 3,000 contracts. This type of action, however, is not that unusual as the rally last fall also saw liquidation in gold and silver COMEX open interest only to see a top form a few days later even as open interest continued to fall. So much for conspiracy theories or Commercials on The Ropes. In truth, it will take a substantial timeframe to establish that commercials are in fact covering short positions en mass due to fear of further losses instead of some other reason. I'll keep an eye out for this as I'm sure most of the gurus will too.

Yesterday, I mentioned Pan American Silver as a "marginal" producer of silver, which was a mistake as I should have said "variable margin" producer meaning that its margin is influenced by fluctuating cash production costs as well as metal prices, unlike Silver Wheaton's margin which is only impacted by silver prices. Well, PAAS reported last night a stellar quarter during which its cash production cost for silver continued to remain extremely low by historical standards, averaging $1.89 per ounce in 2006 which is a 57% improvement over 2005. This is even lower than Silver Wheaton's cash costs thanks to significant by-product credits at Pan American's mines. However, Pan American's profit still remains more sensitive to fluctuating metal prices due to its overhead and other costs, but I probably need to temper the comment that Silver Wheaton is much more of a defensive silver stock than Pan American based on production margins at this point in time. Instead, Silver Wheaton's defensiveness vs. Pan American is probably more the result of SLW's direct leverage of silver prices to its bottom line earnings.

Indeed, two other major silver producers, Hecla and Coeur, have also been enjoying increasing earnings after struggling to post decent profits as the metal bull market has raged. These two silver companies are somewhat further out on the scale in terms of price sensitivity compared to Silver Wheaton and for some silver investors they may represent an interesting investment opportunity. For example, Hecla's 2006 trailing P/E ratio is just over 14 while Coeur's is a little less than 16. Also, it is difficult to imagine Coeur getting beat down much lower than it is already.

FEBRUARY 21 2007 2:00PM - Silver and gold each up over 3% as a slightly higher than expected (0.3% vs. 0.2%) increase in core CPI inflation was all the spark the precious metals needed to fly. Crude oil also helped as it went up on geopolitical tensions while the dollar also rose but did little to hamper the metals' impressive move. As mentioned yesterday, silver and gold were in perfect position for a powerful technical rally. As it currently stands, both metals are in genuine breakout territory but it wouldn't be that unusual to see a reversal. Further, silver and gold are now less than 10% from their bull market peaks from last May and therefore represent an acceptable entry point only for the nimblest of momentum traders.

Having said that, there are still some silver stocks which represent good value for the money in the mid to longer term. Therefore, it would still be appropriate to make moderate and selective purchases at current levels especially for those who are severely under-allocated in silver stocks. I've talked about many of these stocks in previous commentaries. So instead of repeating myself, I am going to explore a different way to look at a few silver stocks that have recent news out with significant implications.

First up is Pan American Silver, one of the Big 3 silver stocks which many investors shy away from because of its size (over $2 billion market cap) and share price (near $30). Yet despite its size, Pan American just announced that it has added 20% to its Proven & Probable Reserves net of 2006 production, an admirable feat. No wonder this stock has lately outperformed silver bullion as the chart below shows. Yet PAAS has not yet recovered its full leverage to silver from the beginning of 2006. What I am trying to demonstrate here is that silver stocks should be viewed in relative terms and there are solid, profitable strategies to be found with most of them. Although I don't personally view PAAS as the most prospective at the present moment, it certainly deserves some consideration especially if you think silver prices are headed much higher in the near term (more on this in a moment)

Next I wanted to follow up on Silver Wheaton, which is also one of the Big 3 silver stocks and is not widely owned by retail investors due to a belief that it is simply too large to generate big returns. Skirting that issue, I have discussed Silver Wheaton at various times in the past as having a revolutionary model that will change the face of mine finance. Recently, however, I have started to doubt the near term probability of such a bold prediction especially as Silver Wheaton has settled for taking equity stakes in junior explorers with large silver deposits instead of acquiring new streams of silver production. Therefore, it is somewhat heartening to hear that Silver Wheaton is Looking for Deals and I hope these deals are true to form. In particular, the clock is ticking on Silver Wheaton's option on silver production from Penasquito (owned by Goldcorp). Like PAAS, Silver Wheaton made significant strides in 2006 despite its size (Silver Wheaton More Than Triples Fourth Quarter and Annual Results). Unlike PAAS, however, SLW has not outperformed silver bullion of late as the below chart shows. This may be partially due to Goldcorp making a secondary offering of some of its SLW shares in late 2006 which created quite a bit of new supply to the market. Yet one of many positives to Goldcorp's reduced stake in Silver Wheaton is that it is no longer the controlling shareholder and this should reduce any conflict of interest in negotiations surrounding the Penasquito option.

A technical analysis of PAAS and SLW might conclude that PAAS is likely to outperform SLW in the coming months. Yet there are several important factors which should be kept in mind. One of the most presently relevant factors is that SLW might be more of a defensive silver stock at this point and PAAS might be more of a momentum stock. To wit, they are likely to behave differently depending on which way silver prices are headed in the near future. This is partly because PAAS is a variable margin producer with significant sensitivity to both rising and falling silver prices while SLW enjoys wide margins which are not in grave danger even if silver falls to $10. The above two charts provide some visual support for this hypothesis. Therefore, the decision in the short term between owning SLW and PAAS may come down to each investor's belief about where silver prices are headed in the near future. The long term involves a more complex analysis and at some point I hope to fully flesh out an investment approach for each silver stock that takes many of these considerations into play.

In the meantime, I will keep making cursory overviews of prospective silver stocks such as Silver Quest, which has just announced some interesting drill results at its 3Ts project in BC. This is certainly not an ore deposit as yet but the company's potential is positive considering that with less than 20 million shares outstanding (24 million fully diluted), Silver Quest has a market cap under US$12 million. Furthermore, the company has several other projects currently under exploration. But what might make Silver Quest particularly interesting is the management expertise along with the fact that the mineralization discovered so far might be amenable to bulk mining. Also, the grade is rather low which certainly creates some risk but also increases the leverage to metal prices. In summary, Silver Quest is a high risk, pure exploration play which can still be acquired on the cheap. The reason I bring this stock up today is that it is a good contrast to the Big 3. I do own some shares of Silver Quest and Pan American (not major positions) and may in the near future look to build a defensive position in SLW (most likely at the expense of PAAS).

The last thing I wanted to discuss today is an analysis of the Production of Large Silver Mines Through 2030 based on the Top 20 Undeveloped Silver Deposits according to Mines Management. As has been pointed out, this Top 20 list is somewhat incorrect but it isn't so far off as to totally negate its usefulness. In the analysis, the production of these Top 20 deposits was combined with the anticipated production from large existing mines and compared to anticipated silver demand to show that an annual deficit of 500 million ounces of silver might exist by 2030. Furthermore, the supply deficit would presumably start expanding in 2011-2012 and never look back. While this is an interesting exercise, the analysis is unfortunately missing a number of important factors and makes unsubstantiated assumptions that create significant doubt about the accuracy of its conclusions. For example, demand is assumed to grow at constant rates year after year while the majority of mine output (from smaller mines, which make up over 60% of annual silver production) is completely ignored. In addition, the effect of metal prices on production due to mining previously uneconomic deposits is not considered. Regardless, I applaud the effort and hope that it will be built upon by Mr. Blake or others to create a more accurate model. Ideally, GFMS, CPM Group or other professional outfits with expertise and capacity should make public their own long-term projections.

FEBRUARY 20 2007 3:00PM - Silver down only about 15 cents (1%) as gold drops over $10 (1.5%) in sympathy with falling crude oil and a slight rise in the dollar. This is actually quite a healthy development as both silver and gold were due for a rest and now have neared the bottom of their up trend channels from which powerful technical rallies can sometimes commence. Meanwhile, fundamentals continue to be muted.

There is quite a bit of commentary out in the past few days that provides guidance on near-term and long-term silver and gold prices as well as various topics related to the precious metal markets, yet there doesn't appear to be anything new or compelling. Perhaps this is the result of the prolonged and (relatively) orderly nature of the ongoing rally or simply everybody being careful. In any case, I am going to remain faithful to the mission of this website by focusing the discussion and postings on need-to-know and must-act-on material (of which there is currently a dearth). On the left bar of the home page, however, I provide links to a wide range of sources that cover the silver market. I pore through these sources every day and I encourage everybody to do the same since I'm sure these sources contain many market nuggets that I have failed to uncover.

One topic which seems to be making the rounds in the past few days is an important one to the silver market: the emerging uses of silver as a nanotechnology antibacterial agent. A couple of examples from the current roundup include this and this. It seems like every type of product from hospital pajamas to socks, bandages, food containers, spray disinfectants and washing machines is being laced with "silver nano particles", which are being touted as the ultimate germ fighters. A number of prominent metal analysts have even ventured to predict that germicidal use of silver is set to become a major source of new demand in the next few years.

Personally, I have some major reservations about this. First, there have been few scientific or medical studies that prove the efficacy and efficiency of silver as an antibacterial agent in real world situations. Yes, silver clearly works to some degree, but can its benefits be measured and quantified? Not yet, it seems. Second, just how much silver will actually be used in the nanotechnology industry if and when silver is widely accepted for its antibacterial properties? I've read various reports but my own estimates place the total amount of silver that might be used in this manner in the range of several million ounces per year. That is good for demand but by no means spectacular. Third, there might be a backlash against silver from environmentalists (who are some of the very people who might otherwise be drawn to silver as a natural alternative to chemical germicides) because many of them suspect silver to be toxic to the environment. In fact, the EPA has recently launched a program to look into nano particle silver in consumer products and the FDA is also increasingly getting into the act. It is not clear what the result will be but this article gives a pretty good overview of the current status. In summary, the jury is still out on the impact on silver demand of the emerging nanotechnology/antibacterial industry and it is likely to be a few years before a significant effect, if any, will emerge.

Finally, I wanted to point to yet one more market commentator - Lord William Rees-Mogg -- who apparently views rampant monetary inflation to primarily be an asset price phenomenon as opposed to a price driver of goods and services. Lord Rees-Mogg does believe that rising asset prices will eventually trickle down to goods and services but admits this has not happened yet. In the context of my prior inflation/deflation discussion, this is important because the rising price of gold so far has not been the result of hidden price inflation as is claimed by many commentators but rather due to the same global liquidity which has alit the prices of many asset classes from real estate to stocks, bonds, commodities, art, etc. The consequence of this is that CPI and PPI are likely to be more accurate than most detractors tend to suggest. Therefore, the inflation-adjusted price of gold in terms of general price inflation may turn out to be properly measured by CPI after all. And unlike others who prefer to measure gold with reference to a one day spike high of $850, I think a more valid measure of gold's current potential would be the average gold price (e.g., moving average) near the top of the previous bull market. This same method could be applied to silver. In fact, over the next few weeks when I have a little more time, I plan to create a chart of the long-term fair value of gold and silver in relation to general price levels as a means to help gauge the current price level of precious metals compared to historical norms. I have not yet seen this type of analysis on the Internet, so if anyone wants to beat me to the punch, please go ahead.

FEBRUARY 19 2007 5:00PM - Light overseas trading and little change in silver and gold on this U.S. Presidents' Day.

COMEX open interest in silver is up to almost 158,000 contracts of combined futures and options and is starting to reach extended levels while the open interest in COMEX gold has actually reached record levels. In particular, the commercials have been increasing their short positions to accommodate the rise in large speculative longs. Meanwhile, retail nonreporting positions are largely sitting out this move. This is a familiar pattern that has preceded the end of each precious metal rally during the current bull market and while the party can certainly go on for a while longer, the fat lady can be heard in the background practicing her solfeggio in preparation for the last song.

As COMEX open interest has grown, so has COMEX warehouse stocks of silver which now stand at more than 116 million ounces. Still, the pace needs to pick up if there truly is some suspicion out there that another run on COMEX silver is about to be made. Therefore, this is an important indicator to monitor in the next two or three weeks.

Next up, the NAV on the silver ETF continues to remain low (0.40%) which may be an indication of subdued ETF investor appetite for new silver as the 5 million ounces added almost two weeks ago continues to be digested.

Finally, I wanted to mention that I am going to be quite busy this week with various projects and my daily commentary is likely to be abridged and focused solely on critical developments, if any. Furthermore, I have not had time to update the silver news and commentary and will only be able to do so sporadically as the week progresses. As usual, new material will be easy to find since I always highlight in yellow the current week's additions.

FEBRUARY 16 2007 1:00PM PDT - Silver up 5 cents to close at $13.95 and gold up almost $1.90 to close at $668.50 (based on Kitco prices) as crude oil and commodities in general were firmer on a day when the dollar also found its legs. Economic reports, meanwhile, painted a picture of moderating inflation with core PPI up 0.2% (overall PPI fell 0.6%) and a struggling housing market, renewing worries about the possible economic impact of a housing bust. Given this data, the markets did not appear to move in the expected direction today (one might argue the dollar should have been down) but this can probably be explained by the complicated economic picture that is emerging. It appears to me that traders in many markets are picking through the data and finding themes to support their positioning while ignoring everything else as market noise. And while that strategy can be effective at certain times, I'm suspicious about its propriety at inflection points such as the current situation. Yet one more reason to remain cautious and vigilant.

I would like to expand on my discussion yesterday of the 2006 gold supply and demand figures by pointing out that the general impression in the media to the World Gold Council (WGC) announcement is that gold demand appears to have increased during 2006. Yet it was only the dollar amount of gold demand that increased while demand measured in tons actually fell by 10%! Now, why didn't WGC headline the fact that demand for gold actually fell during 2006? Could it be that they want to put the best face on the gold market realizing that we might now be in a new paradigm where the total dollar demand for gold may rise year after year even as the traditional measure of demand (tons or ounces) will stagnate or even fall? This brings up an interesting point that I have seldom seen discussed by the precious metal analyst camp: some traditional gold markets have a finite supply of dollars to spend on gold and therefore higher prices may mean lower overall demand in those markets. For example, will the Indian gold market -- which has historically been responsible for 20-25% of global gold demand -- be able to maintain that percentage as the gold price rises? More pointedly, could this effect (greater dollar demand but less tonnage demand) be largely responsible for that ubiquitous market truism that higher gold and silver prices result in greater investment demand? Sure, when investment demand is measured in dollars, it is easy to see this truism as happening (not only in precious metals but virtually every market). Yet what about physical demand itself? Seems to me that if the latest data represents a trend and not an anomaly, a lot of thinking needs to be rethought about precious metals somehow being a special investment category where higher prices drive incrementally higher demand.

On a different note, I also would like to follow up on yesterday's discussion about the inherent problems with silver basis data. At long last, I have decided to chart the daily basis figures starting with last November, which is when I began to religiously track it. The chart can be found here and can also be accessed by clicking on the little symbol next to the daily basis in the Market Indicators table on the home page. A few caveats. The data in this chart has not been normalized and therefore it likely contains pricing artifacts that tend to muddle the picture. Also, it is difficult to show the absolute basis and relative basis on the same chart because of the orders of magnitude separating the two figures (later, I will chart these separately). Lastly, the absolute basis will tend to decline as it approaches a futures month and suddenly jump when contracts are rolled to the next futures month. Therefore, the large swing in the absolute basis at the end of last November should be ignored (the futures contract was rolled at that time from December 2006 to March 2007).

For those who haven't read the explanation of the basis, the absolute basis is the difference between the spot price of silver and the futures price for the nearest contract delivery month (currently March 2007) while the relative basis is the absolute basis divided by the number of days remaining until option expiration for the nearest contract delivery month (as of February 15, the March 2007 options expire in 7 days, so the relative basis is equal to the absolute basis divided by 7).

Although this initial attempt is limited in its usefulness, there are some interesting patterns that appear worthy of comment and further analysis even on such a rudimentary chart. I'll try to cover this next week as well as publish long term historical charts of both the silver and gold basis going back to the 1970's. For now, I am hopeful this chart will turn out to be the humble beginnings of a powerful new approach to studying the silver market.

FEBRUARY 15 2007 3:00PM PDT - Give and take in silver and gold today as the metals continue to struggle with resistance while the dollar and crude oil settle down after several days of frantic trading. Little has been accomplished by the markets this week on a technical basis and so it appears traders will have to remain patient a while longer.

A slight premium has returned to the silver ETF which may indicate that the dealers are having some success distributing the 5 million ounces of silver they added to the ETF holdings last week. I have not yet completed my analysis of ETF premiums and trading volume so I don't know if a 0.81% premium is significant but I do know that it is neither unusual nor extreme. More on this hopefully in the next few days.

Basis Realities

Today's reading of the basis in silver (minus 7 cents absolute and minus 0.9 cent relative) is a good example of the problems with basis calculation that have prevented me from fully analyzing and charting historical silver price data.

The problem is two-fold. First, cash settlement prices as reported for the COMEX are often incorrect or subject to subsequent adjustment. For example, the COMEX cash silver price for yesterday, February 14, 2007, is currently being reported by various sources as 13.93, 13.96, 13.97 or 14.04 (I suspect that some of these sources are using the London fixing, Kitco price or other source instead). Sometimes one source appears more accurate while at other times a different source appears to be correct. Since normalizing the data by switching between sources would add a degree of subjectivity, I have refrained from doing so in the past. I may yet have to do this in order to be able to make sense of the historical data but I hesitate to normalize the daily figures. This can result in anomalies such as today's basis reading. Had I used an alternate source of pricing, the basis reading could have been as high as plus 4 cents absolute and plus 0.5 cents relative.

Second, daily volatility in the silver price (particularly near close) can introduce differences between closing futures and spot prices that mask their true relationship during the trading day. That is to say, the basis may be in flux throughout the day resulting in an average basis which is much different from the closing basis that I report. Since the closing price is just a snapshot in time, it can naturally only tells us about the last trade of the day.

The reason I bring up these issues is because I want to make sure everyone is aware of the limitations in the basis indicators. In the future, I plan to improve on my methodology to minimize or even eliminate these problems but for now I seem to be one of the only -- if not the only --  person to regularly track and discuss this subject in the public domain.

ETF and Supply/Demand Revisited

The World Gold Council reports Record Dollar Demand for Gold in 2006. This is not surprising given the rise in gold prices but what might be interesting to some is that actual demand in terms of tonnage has declined moderately since 2004. In fact, the consulting firm GFMS, sponsored by World Gold Council to produce an annual gold survey, has increasingly relied on sources of identifiable investment demand to help balance the supply picture in gold as jewelry demand first stagnated in 2005 (against a backdrop of rising supply) and then actually fell in 2006. Therefore, we see that increasing ETF holdings in gold have been included as a source of "identifiable" investment demand as if such demand is the equivalent to the minting of new bullion coins and bars or jewelry fabrication (each of which involves changing gold from one form into another).

In reality, the source of ETF bullion is unidentifiable yet it is clearly bullion owned by somebody else before it becomes bullion owned by the ETF. As a result, I would argue that it is not appropriate to break out ETF demand as a category on the same level as fabrication demand. This line of reasoning is similar to the commentary last year titled The Myth of the Gold Supply Deficit in which it was argued that gold supply really represents all available above ground investment holdings. Thus, annual mine supply and recycling are but a drop in the bucket when compared to investment sentiment, of which ETF demand is clearly a part. In further support of this, I would like to point to a secondary "plug" that GFMS had to create in order to make the numbers work -- the so-called category of "Other retail investment" which has supposedly been negative in the past three years! Please note that this plug is on top of the venerable "inferred investment" plug which at times in the past has also been called "implied (dis)investment".

I believe GFMS first got into the problem of mistaking investment sentiment for bona fide supply and demand when it included mine hedging and central bank gold sales in its figures a few years ago. It should really have kept these figures in separate tables but once down the path, it was difficult to turn back. Also, even if misleading, the data as presented by GFMS does seem to make sense when it is viewed as the "visible" portion of the market. Unfortunately, as we are all painfully aware, it is primarily the "invisible" part that drives the precious metals.

In the case of silver, the GFMS approach may create an interesting situation for 2006. As I discussed on February 9, the inclusion of ETF demand in silver supply and demand figures would probably leave a rather large and unstable "plug" in the form of "implied" or "inferred" (dis)investment for the year. Assuming that silver fabrication has not dropped precipitously in 2006, the plug would be somewhat similar in size to the ETF demand itself, which would clearly point out the folly of breaking out ETF demand just because it is a visible component (of a much larger but invisible picture). I guess we will just have to wait and see how GFMS plans to deal with this when it publishes the 2006 silver market summary.

In the meantime and if gold is any indication, an interesting trend may be in the offing. I am talking about the possibility that the precious metal ETFs may so far have done nothing more than substitute one form of demand for another (and not necessarily all that effectively). In the 2006 supply and demand figures prepared by GFMS, this is easy to see. "Jewellery" consumption apparently dropped by almost 350 tons between 2005 and 2006 while the ETFs picked up 265 tons, or roughly 75% of the slack. No doubt jewelry demand dropped as a result of higher gold prices, but this doesn't negate the apparent fact that the ETFs failed to pick up as much gold as jewelry dropped. One possible interpretation of this is that jewelry demand at gold prices above $600 is more price sensitive than ETF demand.  More importantly, the real impact of ETFs on the gold market may come when jewelry demand becomes less sensitive to gold prices relative to the ETFs. In particular, I am curious to observe how this might play out with lower or more stable gold prices: could both jewelry and ETF demand increase, for example? I'm also looking forward to studying the pending silver figures to see if there might be a similar relationship between the silver ETF and silverware.

Interconnected Smorgasbord

A plethora of interesting topics -- with indirect but important implications for the silver market -- were covered today by various news and editorial sources. I'll try to spin them together in a way that hopefully shows why it is important to remain rational and even handed when it comes to studying the markets.

First off, I have long held that governments and financial market participants have an incredible range of creative (and dangerous) tools at hand to mitigate what at times can appear to be impending financial disasters. For example, derivatives have provided a means by which economic risk has been spread across the global financial system at the same time that systemic risk has been concentrated in the hands of a few money center banks. The "beauty" of this may not be clear to those who disdain or do not understand modern financial practices: governments cannot allow money center banks to fail and therefore the collective will of 6 billion people is behind our current economic "miracle". This means that a financial shock would have to be very massive in order to derail the arrangement, which is precisely the opposite of what many people argue (that a minor event could precipitate the end). So yes, derivatives are a house of cards that can bring everything down, but the flip side is that the house is going to withstand more than a few puffs from the hungry wolf. Where am I going with this? The sorry state of the housing market, of course! Specifically, a New Way to Hedge Your Home's Value which doesn't appear to be a hedge at all but rather a way to tap future, nonexistent equity from a house just in time to supplant the traditional sources of mortgage funding that are starting to dry up. I have privately argued for some time now that many new financial products will be created before a residential housing meltdown might successfully become a depression-inducing catalyst and blow down the financial house of cards. This new "mortgage product" is likely to be just the beginning.

But that doesn't mean the day of reckoning can be permanently put off so everyone should start (or continue) to keep 10% of net worth in gold and silver bullion in their own secure, hidden, direct possession. More importantly, as I have mentioned before, this discipline should be passed down to future generations because that is how long the game of musical chairs might go on despite the incessant calls from the doom and gloom crowd that the sky is falling. But please do be careful to purchase bullion from reliable sources so you don't end up being a plaintiff in an affair such as Coin Companies Accused of Defrauding Consumers, Targeting the Elderly in Texas Lawsuit. Instead, read my Bullion page and other sources on the Internet to learn which dealers are reputable and how to best invest in bullion. I plan to add much more useful information to my bullion section so please keep checking back.

Next, we hear that it is apparently the End of the affair for commodities as far as institutional money managers are concerned. Instead of worry, however, we are heartened by the news for it surely means there is life yet left in this bull market.

Continuing on, we illustrate our doubt about the sanity of those who despise central banks in favor of government control of money by pointing to episodes such as Bernanke, Sparring With Frank, Says Fed May Lift Rate. Am I the only one who believes that our monetary system would have been destroyed more than a few times since 1913 if the federal branch of our government was directly behind the driver's seat of money creation? True, there isn't that much to celebrate when it comes to the dollar, but I still think the Fed deserves a subdued Yip, Yip, Hurray! for being able to keep the party going for so long. Our current standard of living, such as it is, can be directly tied to the Fed's (not always successful) effort to remain apolitical and nonpartisan.

Finally, lest we get too lucid and giddy about the future, Chris Puplava gives us A Bird's Eye View of the U.S. Consumer showing just how much trouble there is to dig out from.

FEBRUARY 14 2007 10:00AM PDT - Silver and gold first rise sharply, then hit by significant selling pressure as they attempt to cross resistance with the help of a dollar free fall on Bernanke's softening rhetoric on inflation. The dollar is trading around 84 on the index and appears very unhappy that prospects for a rise in interest rates have become a little dimmer. It is quite possible that the dollar will now continue to weaken which could be the boost the precious metals need to break free and soar to new highs. I am not confident enough about this scenario, however, to change my comfortable stance. Therefore, I continue to maintain significant exposure to the upside by holding quality silver stocks while limiting risk by culling illiquid, highly speculative companies from my portfolio as well as maintaining a significant amount of dry powder.

There has been very little change in the silver market indicators over the last two days and I continue to await confirmation that metal supply is tightening. For now, this does not appear to be the case so I still believe the current market action is technical and seasonal in nature. What this means is that a substantial move higher will more likely be in the form of a spike, perhaps difficult to trade, then a sustained rise.

FEBRUARY 13 2007 12:30PM PDT - Spot silver was up approx. 1.5% for the day to $13.85 as it raced away from gold which was almost unchanged despite a sharp drop in the dollar (due to report of big trade gap) and a strong rise in crude oil (expectations of higher demand in 2007). Today's action in silver appears to be a recalibration of its position vis-a-vis gold as opposed to independent price action. Both silver and gold are obviously still looking for that excuse to break free from their reigns with the likelihood of resolution growing by the day. Unfortunately, there isn't a high probability of either a break higher or a reversion lower at this point. Therefore, a careful precious metals trading portfolio should ideally be balanced as to both upside exposure and downside risk.

In my own case, this has meant trading out of the more speculative, illiquid positions into liquid, high quality stocks while continuing to hold significant amounts of cash. A similar positioning is probably also warranted for strict buy-and-hold portfolios although to a lesser extent -- for example, this might be a good time for any re-balancing left over from tax-loss selling. On the other hand, those investors who are underexposed to precious metals should still find it possible to slowly build a portfolio at current levels but I would emphasize the world "slowly" because many of the premier silver stocks are quite richly priced at the moment. This isn't necessarily a bad thing since 52-week highs are likely to be surpassed in the future, but investors looking for less of a sticker shock are left with a small if interesting field of possibilities including Avino, Bear Creek, ECU Silver, First Majestic, Impact and Silver Wheaton (of these, I currently own First Majestic and Impact).

Moving over to the fundamental side, COMEX warehouse stocks of silver have climbed above 115 million ounces with the Registered category in a clear up trend as my updated chart clearly shows . This pace, however, will probably need to accelerate before we can conclude that traders are anticipating a large volume of physical delivery on March COMEX futures contracts.

In the meantime, the NAV on the silver ETF has quickly plunged into negative territory (a discount of 0.66% as of this Monday) after last Thursday's premium of almost 2%. ETF trading volumes last Friday and this Monday were good but not spectacular and certainly not sufficient to eat through the 5 million ounces of silver added by dealers last Thursday. That is, ETF dealers are probably still holding most of the ETF shares they acquired last Thursday when they delivered 5 million ounces of silver to the ETF. They most likely acquired the ETF shares in an effort to take advantage of the hefty 2% NAV premium that existed in the ETF last week, but as of yesterday, this premium turned into a 0.66% discount as dealers appear to have aggressively sold into the premium. Since there wasn't much of a resulting increase in trade volume, it should be apparent that retail and institutional silver demand via the ETF is probably not as strong as last week's 5 million ounce addition would imply. On the other hand, silver demand tends to fluctuate wildly and the 5 million ounces may yet be absorbed by ETF investors in the coming days. One sure sign of this would be the return of a healthy NAV premium. I'll keep my eyes peeled.

Finally, I wanted to briefly mention a couple of news articles which may help to refine my discussion of the base metal tug-of-war which I described a few days ago. The first is Base Metals – The fundamentals still matter which strikes me as a well-balanced and realistic assessment of important market fundamentals during the next year or two. What I find most interesting about this analysis is that it attempts -- in broad strokes, unfortunately -- to explain not only the various factors expected to influence metal supply and demand but the sensitivity of metal prices to those factors as well. One of those factors is the possible disruption to mine supply due to expropriation such as that currently taking place in Bolivia. It appears that not only mines but smelters and presumably other infrastructure providers are at risk of nationalization, a process which at a minimum will temporarily disrupt operations if not permanently impair operating efficiency. This, of course, is quite ironic given the official reason for the seizures: under-utilization. So perhaps we should not rule out the near-term possibility of elevated production from nationalized mining infrastructure since there will be quite an incentive to prove that socialism works. In fact, it may take a few years before the well-documented impact of a centrally-planned, non-incentive based economic system begins to exact its toll in the form of declining production and inefficiency.

FEBRUARY 12 2007 12:45PM PDT - Silver and gold significantly lower as the dollar climbs just above 85 on the dollar index and oil prices drop on supply data. This week should be interesting as the precious metals remain near resistance levels which, if cracked, could portend a breakout to much higher prices. On the other hand, a failure to surmount the resistance zone could result in silver and gold trading back down toward the bottom of their recent range. I personally do not feel very confident about the probability of either scenario taking place because there are strong arguments for both higher and lower prices. Therefore, I believe the best approach right now is to be ready for either possibility and to patiently await which one it actually turns out to be.

While this wait-and-see approach is favored by a number of commentators at the moment, the cautiousness is generally overshadowed by fantastic predictions of the near term riches to be had in precious metals as the following small sampling of recent prognostications seems to suggest:

Timing the Gold Bull: Fireworks on the Horizon

Precious Points: Now Boarding the Flight to Quality!

HUI Index Set to Advance to 700 - 900...

The AMEX GOLD BUGS INDEX (HUI): Still a Golden Opportunity to Buy Gold Shares? Follow-up No. 6

An Objective Look at Gold and Gold Stocks

Most significantly, some of these comments represent 180 degree reversals from just a few weeks ago apparently due solely to rising prices of silver and gold -- prices which have yet to break free from resistance.

Further, the current situation is set against a backdrop of consensus estimates for 2007 which predict higher gold and silver prices compared to 2006.

Looking at the overall sentiment, it appears to me that the bull train in precious metals is pretty much standing room only at this point. And while seasonal and technical factors do point to a major rally, there remains a significant amount of risk that is probably being overlooked by the majority of analysts, experts and investors.

FEBRUARY 9 2007 4:00PM PDT - Silver and gold rocket higher on technicals and speculative fear while crude oil and the dollar vacillate. For the day, silver is up 15 cents (over 1%) while gold is up $9 (1.3%) but both are still just a hair shy of full breakout mode which would occur once the secondary highs -- just a few ticks above now -- from July 2006 (for gold) and December 2006 (for silver) are surmounted. Action early next week could be critical. In the meantime, precious metal stocks refused to play along as both the HUI and XAU were in negative territory at the close with many individual silver and gold stocks fairing rather poorly.

The dichotomy between precious metals and mining stocks is likely due to Fed comments (not by Bernanke but a couple of Regional Presidents) to the effect that persistent inflation may prompt the Fed to raise interest rates. No timeframe was given but the markets are on pins and needles (see my comments from yesterday) such that even an accidental brain fart from the peanut gallery is bound to set of a bout of panic selling or buying, as the case may be. What I'm trying to say is that gold and silver were up on inflation fears due to a healthier-than-expected economy while mining stocks were down on interest rate fears in sentiment with the general equity markets. No, it doesn't make sense to me either!

Silver ETF Boom

An apparent strong positive for silver is the 5.5 million ounces added yesterday by the silver ETF (SLV) which puts its holdings at a new record of 125 million ounces. On the other hand, ETF investors did not have the stomach for that much silver just a couple of months ago and ETF holdings were subsequently pared back. So we might wish to be patient with the current additions to see how they will be digested.

Back in December, I speculated that the large addition then to the silver ETF might be due to short covering by dealers but I was probably incorrect. Instead, it appears to have been an attempt by dealers to buy low and sell high, which they apparently failed to do on that go around. The January reduction in ETF holdings was likely the result of that failure. It is possible that the current increase is a second attempt by dealers in which case we could see a similar pattern played out in March.

The key to understanding this might perhaps be found in the Net Asset Value (NAV) of the silver ETF as it compares to the trading price of ETF shares. As of yesterday's close, there was a premium to NAV of almost 2%, meaning that ETF investors were willing to pay (some maybe did not realize they were paying?) 25 cents or higher per ounce of ETF silver than the spot price of its outright bullion form. This is obviously an incentive for ETF dealers to buy silver in the spot market and sell ETF shares to make an arbitrage profit. Assuming the dealers can sell 5 million ounces of silver to ETF investors at nearly 2% premium to NAV, they stand to make up to $1 million in profits which is not entirely bad for a few days work. In the meantime, the dealers are likely to be hedged against downside exposure which means the net impact on overall silver demand will not be felt until the newly created ETF shares are acquired by investors, at which point the dealers can lift the hedge. To the extent some ETF shares cannot be unloaded by the dealers at an attractive premium to NAV, the ETF holdings will subsequently fall and the impact on the silver market will end up being minimal to nonexistent.

I don't believe I fully took these considerations into account last December when I was trying to make sense of the increase in ETF holdings but I plan to rectify the situation shortly by creating a chart which compares ETF holdings to NAV premium/discount as well as the price of silver and ETF trading volume. Hopefully this will help create a little more transparency as to what is going on as well as to give me -- along with those who bother to study my analysis -- a superior understanding of ETF impact on the silver market. As a start, I am now including the silver ETF NAV in the Silver Alerts on the home page since I believe this may be (or become) a more important short term indicator for investment demand in the silver market than the actual level of silver held by the ETF.

As to those who might innocently think that the increase in ETF holdings of 5.5 million ounces is due strictly to existing investor demand, I would suggest you look at the daily trading volume of SLV, which has not been particularly spectacular in the past few days. As I said above, the NAV may turn out to be the overlooked factor that helps put things into better perspective. I will know better in a few days once I've had a chance to create and analyze the charts.

Further on the topic of misunderstandings about the silver ETF, an article titled Silver Demand that is out today attempts to forecast 2006 silver demand by adding the increase in ETF holdings during 2006 (over 100 million ounces) to the demand figures published annually by metal consultant GFMS.

This is plain wrong since investment demand according to GFMS is simply a "plug" which balances their supply and demand figures. This is so because there is no direct method to gauge investment demand -- after all, for every buyer there is a seller. Instead, what GFMS does in its silver survey is to assume ("implied" in their own words) that only new supply of investment grade silver -- either from mining or recycling -- can represent new (net implied) investment demand. Their approach is largely correct but it does create some problems.

The main problem is that the underlying mining supply and recycling figures as well as industrial and other demand figures must ALL be fairly accurate in order for the net investment demand, the "plug", to be fairly accurate. Stated another way, the plug is dependent on every other variable and therefore it has the greatest probability of being wrong by the largest margin. I personally believe that the GFMS figures simply represent a reasonable range which in some instances could be off by tens of millions of ounces. This is inevitable due to the lack of transparency in certain sectors such as government sales as well as the inherent limitations in survey techniques. But this doesn't prevent GFMS from using fractions of a million ounces -- a presumed precision level of one hundred thousand ounces -- which tends to create a sense of accuracy which simply is not there. The result is that there is actually a lot more wiggle room in the level of investment demand reported by GFMS than it might appear.

So what is the proper way to look at ETF silver if it does not directly represent net investment demand nor can it be used in the context of GFMS supply and demand statistics? Simply, the movement of silver from one holder -- who may or may not be an investor -- to a bona fide silver investor (although some ETF silver is no doubt held in the short term by dealers for trading purposes).

For now, we can probably conclude that the ETF is moving metal from weak hands to strong hands. This is quite bullish! Yet in the long term, the increasing concentration of silver in a very liquid instrument could create a dangerous overhang of supply in a panicked market. The implication is that we are probably not going to see a sustained level of very high silver prices toward the end of the current bull market but rather a spike and subsequent crash even more severe than the one in early 1980. Remember that at that time silver was mostly dishoarded in the form of coin and silverware which took time to be melted down and refined into bullion. In contrast, the silver ETF is already holding bullion, all of which can theoretically hit the spot market within 24 hours.

Conspiracy Battle Rages

Clive Maund has just gotten himself involved in a nasty little battle with the conspiracy hucksters. Unfortunately, there are fewer and fewer voices willing to challenge the GATA party line due in part to the conspiracy theorists' refusal to debate on the basis of fact and logic. This is something I have discussed before and will dwell on again. So Mr. Maund, please don't give up but do realize you are facing a quasi-religious movement. You can't win converts by preaching atheism to bible thumpers. And the rest don't care. Yet this debate matters in important ways.

First, the dogma of GATA has seduced and will continue to seduce many precious metal investors to aggressively buy on the way up, culminating with a feeding frenzy at the bull market top. Knowing this, the true and independent contrarian stands to make vast fortunes on the backs of the GATA masses who will be impoverished (more on this in a moment). And I am not talking about those few early GATA veterans who were and still are fully invested in bullion and mining stocks ever since $250 gold and $4 silver. They will probably do well regardless of what happens.

Rather, I'm talking about the innocent masses that GATA is presumably trying to save by warning them of the supposed central bank Ponzi scheme of fiat money and gold manipulation. Yet in doing so, GATA is running a Ponzi scheme of its own, one that places completely unreasonable expectations on the price of gold based on its monetary qualities. Thus $1,000 gold and even $1,500 gold (or $50 silver), if those levels are achieved, will be explained to the GATA "marks" as fabulous entry points. It has to be that way in order for the bull market to continue since if GATA -- as a powerful and vocal proponent for gold ownership -- changes its tone to neutral or bearish, what significant buying will remain and why?

For this reason, GATA should welcome being discredited to a certain extent. Taking this a step further using the typical logic of conspiracy theories, it may turn out that GATA leadership is itself behind the attacks on its own credibility! If so, you should suspect that Clive Maund and others such as myself are actually on the GATA payroll as double agents. But don't worry Mr. Murphy, Powell, etal, we aren't ever going to tell so please keep those juicy checks coming!

Returning to reality, I'll conclude by making an observation about the opportunity to make a lot of money on the backs of poor (if decent) innocents. Unlike GATA it seems, I and apparently others like Clive Maund have a conscience about this sort of thing: while it's not possible to stop the inevitable, it is possible to help those who are willing to think for themselves. Make no mistake about it, the professional money is going to fleece the general public during, and particularly at the conclusion of, this great bull market in precious metals and natural resources. So pardon us if we actually stop for a second to help those whose hands reach out from under the terrible hoofs of a market intent on trampling the unwary or foolish. This is not just about who is right or wrong.

FEBRUARY 8 2007 12:00PM PDT - Silver and gold up moderately today on technical buying and a meandering dollar amid reports that several central banks have been buying gold lately. The central banks apparently doing the buying at this point are not the major ones but it may not take a lot of new physical demand to move gold (and hopefully silver) prices substantially higher especially if the European central banks moderate their planned sales. This is because technicals are already supportive of higher prices with silver and gold looking for a reason -- any reason -- to rumble higher. On the other hand, getting too excited is probably not warranted seeing that current elevated gold prices appear to be drawing out metal for melting if this report is to be believed.

Additionally, my fundamental indicators are not showing any sign that a reason to rumble is developing. One thing that bears watching, however, is the open interest on the March COMEX silver futures as it goes into the spot month which has historically seen a lot of contracts stood for physical delivery. An early indication that this might happen again is the level of COMEX warehouse stocks, which has been gradually increasing from around 100 million ounces late last year to almost 115 million ounces at present. I have charted the COMEX silver holdings since last November and will be updating the chart with historical information shortly. In the meantime, the up trend in both Registered and overall warehouse stocks since November is clear. It appears to me that perhaps half this increase was due to physical delivery on December contracts and the other half is silver Registered in January possibly in anticipation of delivery on the March contract.

An acceleration of silver held in the Registered category at COMEX warehouses into the end of February and early March may indicate that speculators are once again planning a major run on COMEX silver and this could be bullish for prices (or at least blunt any bearishness in the short term) during the next several months. Typically, I would expect an increase to first show up in the Eligible category and this may still happen but the difference in storage costs (Eligible silver is usually stored in lower cost pool accounts) over a month or two isn't big enough to worry about. Therefore, the silver may end up being deposited directly into the Registered category.

There is one more thing I'd like to address and that is the general feeling many people seem to have that holders of Registered silver who sell by delivering on a COMEX contract are somehow stupid or don't know what they are doing. In contrast, those taking delivery of silver in this way are generally thought to be the smart ones. Actually, this is probably the furthest from the truth. The fact is that if you look at silver prices during major episodes of COMEX silver delivery you will find that historically those prices tended to mark the highs for the year. There are a multitude of reasons for this but perhaps the most obvious is that prices tend to peak precisely when demand is at the highest level which is something that obviously will occur when a lot of contracts are being delivered upon. Developments like the silver ETF are likely to have reduced the importance of silver demand from physical delivery of COMEX contracts but not substantially. As a result, sellers of silver into COMEX deliveries will likely continue their very profitable trade of "buy low and sell high".

In reality, big silver traders appear to be very careful in how they use this strategy to take profits since it is possible to overwhelm those standing for delivery in the spot month by refusing to heed the actual level of demand. The result is that if not enough contracts are closed out by the shorts (remember that only shorts can create and close out futures contracts, otherwise longs simply trade existing contracts between each other) then spot silver prices might actually fall, sometimes precipitously. I suspect this has happened on more than one occasion and may in part explain the explosive volatility that can sometimes be observed around major delivery months.

For more on COMEX Eligible and Registered categories including what these terms mean, please see my commentary from December 18, 2006.

FEBRUARY 7 2007 12:45PM PDT - Silver and gold followed a familiar pattern today with a morning rally to resistance levels followed by a drop back for a minor gain. The dollar declined a bit and oil declined a dollar.

I spoke of a tug-of-war in mine supply fundamentals yesterday but there appears to be a more immediate struggle in the silver and gold markets: both the precious metals and the dollar are at key resistance levels and nobody seems to want to give up the ghost. Meanwhile, crude oil may be on its way to completing a round trip from $50 to $60 and back down to $50.

This indecisiveness is mirrored on the economic front, where data is providing little consistency other than pointing to tepid, lackluster performance. Indeed, a timidity seems to be pervading consumer and business sentiment, inflation expectations, the housing market, etc. In this current environment of global waffling, it should not be a surprise that precious metal stocks as a group have gone virtually nowhere in the past 6 months (unless bought at the September-October lows). And although we are still in a seasonally strong period, the window of opportunity is fast closing.

It seems to me that market direction in the short term is dependent on whether or not we get another speculative episode such as the one which drove commodities to their peaks last spring. In my opinion, a repeat of last year's speculative mania based only on a technical impulse (chart pattern breakout, trends, etc.) is unlikely at this point and a major rally would instead require, in all probability, some external stimulus or event.  The likelihood of a triggering event, of course, is quite uncertain but the usual suspects (Iran, North Korea, Bush inanity, etc.) are still out there. Yet I'm not convinced their desire or capacity for disruptiveness is at a high level at the moment.

What I am saying is that an apparent breakout by silver and gold (unaccompanied by a major geo-political event) -- if it does occur in the coming days and weeks --  may turn out to be a false breakout which may not achieve new bull market highs but instead could lead to a major price reversal. As a result, I have intensified my cautiousness toward the silver market. What this means is that I am monitoring my speculative exposure and have taken action to reduce risk and initiate contingency plans should the caution be vindicated. For example, I have consolidated my equity portfolio so that I now hold a smaller group of high quality, liquid stocks which should be easy to trade under volatile circumstances. In addition, I have locked in some gains on high flyers. I have also reviewed the prospects of all my speculative, thinly-traded holdings and sold those which are unlikely to see near-term developments. On a net-net basis, I've only lightened my overall holdings slightly but I did radically change the risk profile of my portfolio.

Please don't get me wrong, I don't believe the bull market is over but I do believe that the next few months may not be an ideal period to be aggressively initiating or adding to positions except for a few special circumstances.

Finally, I have decided not to change my mental alert flag for the short term from yellow to red simply because I don't view the downside as extreme from current levels. For example, I believe $10 is a solid floor for silver and is unlikely to be penetrated other than over a very short term. Similarly, I believe that many silver stocks could bottom not catastrophically below (if 20-40% is not catastrophic to you) the current price.

FEBRUARY 6 2007 1:15PM PDT - Somebody out there seems to be shining a spotlight on Silver Valley stocks today as Silver Fields (a couple of smaller projects in and around Northern Idaho) and U.S Silver (acquired the Galena mine formerly operated by Coeur) are the big winners at the close, each up more than 10%. The move by Silver Fields was on huge volume over 2 million shares (on approx. 30 million shares outstanding) on top of a similar large move on massive volume on Monday. Something is definitely up with this stock which still has a market cap around US$5 million, making it a rather painless speculation if done in minimal doses. In the meantime, current Silver Valley darling and uber-promoter Strategic Nevada was up around 5%, heavy hitter Hecla was up 1% and underdog Sterling was down 2%.

FEBRUARY 6 2007 1:00PM PDT - Silver and gold spiked higher into breakout territory on a declining dollar before settling for moderate gains at the cusp of overhead resistance. Base metals, led by copper, were also higher while the energy complex and other commodities were generally lower. Precious metal stocks were mixed at midday with the HUI and XAU slightly higher amid moderate gains for many silver stocks.

New List of Silver Stocks

I have just revised my listing of silver companies to prioritize them according to silver exposure. I am using "Primary Silver Stock" to designate companies with more than 50% of company-wide production, profits or reserve/resource base attributed to silver. "Secondary Silver Stock" refers to companies with 25-50% of company-wide production, profits or reserve/resource base attributed to silver. These categories do not include thinly-traded, foreign or very small companies which I will classify separately since they are not readily accessible as investment opportunities.

The relative proportion of metal exposure is based on the following normalized prices for the main co-products of silver deposits:

Silver = $10/ounce

Gold = $500/ounce

Copper = $2/lb.

Zinc = $1/lb.

Lead = $0.50/lb.

Note that revisions to the above normalized prices will likely be required in the future and therefore could result in a change of company classification as Primary or Secondary Silver Stock. In addition, changes in the nature of company assets, operations or projects over time will also result in reclassification. Therefore, I plan to review the classifications once a month and make appropriate modifications.

This listing is preliminary and I will be updating the Stocks page in a few days to reflect these classifications. In the meantime, here they are sorted alphabetically (later I will also provide and sort by actual exposure percentages):

Primary Silver Stocks (Over 50% Silver Exposure)

Aquiline Resources Inc.*

Arian Silver Corporation

Avino Silver & Gold Mines Ltd.

Central Fund of Canada Limited

Clifton Mining Company Inc.

Coeur d'Alene Mines Corporation

ECU Silver Mining Inc.

Endeavour Silver Corp.

Excellon Resources

First Majestic Resource Corp.

Fortuna Silver Mines, Inc.

Fury Explorations Ltd.

Genco Resources Ltd.

Great Panther Resources Limited

IMA Exploration Inc.*

Impact Silver Corp.

Klondike Silver Corp.

MAG Silver Corp.

Minco Silver Corporation

Minera Andes Incorporated

Oremex Resources Inc.

Orko Silver Corp.

Palmarejo Silver and Gold Corporation

Pan American Silver Corp.

Silver Dragon Resources, Inc.

Silver Quest Resources Ltd.

Silver Standard Resources Inc.

Silver Wheaton Corp.

Silvercorp Metals Inc.

SilverCrest Mines Inc.

Silvermex Resources Ltd.

Sterling Mining Company

Strategic Nevada Resources, Inc.

Valencia Ventures Inc.

*Based on disputed Navidad project currently in litigation

Secondary Silver Stocks (25-50% Silver Exposure)

Apex Silver Mines Ltd.

Apogee Minerals Ltd.

Aurcana Corporation

Bear Creek Mining Corporation

Canasil Resources Inc.

Chrysalis Capital III Corporation (U.S. Silver)

Energold Drilling Corp.

Esperanza Silver Corporation

Gammon Lake Resources Inc.

Golden Goliath Resources

Hecla Mining Company

Kenrich Eskay Mining Corp.

Kimber Resources Inc.

MacMillan Gold Corp.

Metallica Resources

Minco Gold Corporation

Minefinders

Mines Management Inc.

Revett Minerals Inc.

Sabina Silver Corporation

Scorpio Mining Corporation

Silver Eagle Mines Inc.

Silver Fields Resources Inc.

Silverstone Resources Corp.

Tumi Resources Limited

UC Resources Ltd.

Yale Resources

Boom or Bust?

There appears to be a great tug-of-war forming in the metal supply picture which could be a major macro factor influencing metal prices in the next several years.

On the one hand is an increase in mine supply from new projects coming on line along with possible hedge fund and investor liquidations of speculative positions in physical metal built up during the last two years. Several recent articles discuss this possibility, including Frank Veneroso's Speculation and Price Risks in which he argues that the commodity boom was fed by excessive speculation which has led to excessive buildup of supply and will result in crashing metal prices. A similar argument, although from the angle of excessive liquidity, is made by Adrian Ash in The yen, gold and a losing hedge fund in London. Finally, a slight variation on this theme is expressed in After the Good Old Days of Commodity Prices.  

On the other hand, we have factors arguing against the near-term increase in new mine supply as pressures mount on the production infrastructure and labor required to increase mining activity. This includes everything from the well-documented shortages of truck tires and drills to a dearth of miners themselves as discussed in Mining Manpower Crisis and elsewhere. In addition, there is a growing nationalization of mines not only in Latin America but elsewhere such as Russia (see State to Tighten Grip on Metals). A popular notion regarding this trend is that since government is poor at efficiently running a business, mine output will not grow as fast if a significant portion of mineral resources are nationalized.

So, which side has the edge? My suspicion is that an increase in mine supply stirred by sustained elevated prices and a concurrent release of aboveground hidden stocks by speculators exiting the sector will eventually result in falling metal prices that, in retrospect, will mark the beginning of a bear market in metals. But in the meantime, episodes of speculative fervor, production delays and disruptions due to nationalization, strikes, strife, etc. could drag out the battle for an extended period assuming industrial demand does not falter. And if China and other emerging economies continue to soar without a pause, metal prices will likely rally to new highs and even achieve all time inflation-adjusted highs in the coming years.

So basically the tug-of-war on the supply side might be evenly matched at the moment. Sustained or increasing demand could keep the boom going indefinitely whereas a decrease in demand could start a spiraling regression to the mean. Eventually, of course, prices will reach a point at which long-term supply and demand are in balance. What we don't know at this point is whether that equilibrium is above or below current prices. In the case of gold (and despite Mr. Veneroso's pessimist, we can make a similar case for silver), investment and monetary demand would argue for a higher equilibrium point. The same case is much more difficult to make for base metals. Regardless, the equilibrium point is not something we will be able to recognize with certainty until several years after the fact. This is one of the reasons I remain very cautious in this market and why I prefer gold to be over-represented as the co-product of choice in a silver stock portfolio.

At the end of the day, I believe the key to being right about the silver market at the right time (as opposed to being eventually right just like a broken clock shows the right time twice a day) is to stay focused on the fundamental factors, to remain rational and independently contrarian (thinking for oneself and refusing to accept dogma), and to use common sense. This is how I try to look at investment opportunities in silver and hopefully in the future I can succeed more often then I fail.

FEBRUARY 5 2007 2:40PM PDT - Silver and gold up in the face of a stronger dollar which continues its struggle with the 85 level on the dollar index. The silver and gold strength has technical buying still behind it with encouragement from rising oil prices and increasing geopolitical tensions.

FEBRUARY 2 2007 12:30PM PDT - Silver and gold were not able to maintain their ascendance over the top of a months long resistance zone amid profit taking as the dollar gained strength and worries over Iran eased a bit. Silver ended down more than 30 cents (2.5%)  and gold was down over $10 (1.7%). Meanwhile, the silver ETF added another 2 million ounces and has now fully recovered the decrease from last week. The see-saw action in silver and gold prices along with the rise and fall of ETF holdings might indicate that the conviction required to move the markets much higher is not present at this very moment. Next we need to see if this is a return to the trading range or just a hesitation. If the former, there exists moderate downside to $12 silver and $610 gold in the near term. If we are headed that way and those price levels hold (give or take), a Spring breakout may yet be in the cards. If the latter, the rally should resume in a few days if it is to take advantage of momentum.

Today, I would like to briefly talk about a silver stock which might be poised to hit the mainstream in the next year or two. By mainstream, I mean the likes of Pan American, Silver Standard and Silver Wheaton (the "Big Three"), currently believed by many to be the best and purest silver stocks to own. Well, there are several strong contenders to join that select group, but I believe Endeavour Silver might have an edge. The key is getting a big boost in resources, ramping up production and acquiring another project or two. I believe these are all achievable in the medium term although by no means are they certain. What is certain is that Endeavour Silver's recent AMEX listing (EX) will make the stock easier to own when and if it hits the mainstream radar. Some patience will have to be exercised with a silver stock like this but I believe it has a solid place in a long-term silver portfolio, even (perhaps especially?) as a substitute for one or more of the Big Three. I own a few thousand shares.

I would now like to point out a few relevant, common sense and rational commentaries that have appeared on the Internet over the past several days. They are excellent examples of the type of logic, analysis and understanding that helps create excellent investment opportunities for those who strive to do their own thinking. Although they don't address silver directly, each of these three pieces probably say more about the silver market than the hundred most recent articles focused on silver combined.

First up is a nicely written overview of gold fundamentals by the www.zealllc.com crew that can be applied to the silver market as well.

Second is an excellent article on the rise of credit and the related asset inflation that helps tie together (as well as challenge) some of my recent discussion about inflation, deflation, etc. Lots of great charts and thought provoking material deserving a permanent link. I was especially impressed with the brainstorming around the possible impact on bonds as retiring baby boomers -- with fewer and fewer asset bubbles to chase -- might get desperate for yield.

Lastly, there is an excellent piece on corn ethanol that truly sets the record straight and is a perfect example of why contrarian thinking is so crucial in understanding markets.

FEBRUARY 1 2007 2:00PM PDT - Another strong day for silver and gold although they both sold off the highs into the closing, a feature that has been rather consistent during the recent advance. The move appears purely technical at this point as the dollar was near unchanged with oil and most commodities trading down. The chance remains high that silver and gold might be off to the races in the coming weeks but we are not there at the moment. On the other hand, we are entering a seasonally very strong period for resource stocks and I would find no fault with continuing to add quality exploration and production plays at current prices.

Meanwhile, another explanation of money supply and inflation has appeared attempting to clarify why monetary inflation as measured by M2 and M3 do not directly translate to price inflation of goods and services.

Strategic Nevada vs. Sterling

The saga continues with David Bond returning fire in Setting the Record Straight. Somewhere in the middle lies the truth. But regardless, neither of these companies should be bought for the people. Buy U.S. Silver or even Hecla if you want a Silver Valley play with impeccable management. But if you are looking for an undervalued turnaround scenario, you have a lot of time on your hands and the risks don't frighten you, then you can look at underlying property values..

On that basis, the Crescent is not even in the same league as the Sunshine. First there is the matter of infrastructure: the Sunshine pretty much has everything it needs (although some additional facilities would be nice like the metallurgical complex now owned by Formation Capital) while the Crescent pretty much has none. Beyond that, consider historic ore reserves. I quote the following from SEC filings made in 2000:

"Sunshine's share of silver reserves at the Sunshine Mine as of December 31, 1999 were estimated to be 1.23 million tons of ore with an average grade of 23.65 ounces of silver per ton (after adjustment for mining dilution), containing 29.18 million ounces of silver."

Meanwhile, here is what we find for the Crescent:

"The most current ore reserve report that the Company has been able to obtain was prepared in 1985 by Norman A. Radford, a registered professional geologist. That report, based on an assumption that silver prices would remain below ten dollars ($10) per ounce, indicated that the Crescent Mine contained 141,000 tons of probable reserves averaging 31 ounces of silver per ton of mineralized material."

Now, keep in mind that the Sunshine figure represented then-current ore reserves calculated according to strict SEC reporting guidelines by a public company while the Crescent report is just that, a report. And just who is "the Company"? That's a story for a different day although I encourage you to do your own research if you are interested in finding out.

The bottom line is that the Crescent may or may not have a lot of silver which could be discovered by drilling. But the Sunshine already has a lot of silver as well as the facilities to process it. In addition, there will be as much if not more drilling at the Sunshine compared to the Crescent. Finally, more than 3 years of fits, starts and mistakes have hopefully given the Sunshine people the experience to credibly attempt to reopen the mine in the next year or two.

After the recent financings, Sterling and Strategic Nevada each sport a shares outstanding tally a little shy of 30 million. Therefore, we can make a direct comparison of stock prices to see how the company valuations stack up. Yes, the obvious imbalance could become more skewed in favor of Strategic Nevada but probably not by much. If it did, Sterling would become more and more attractive as a pure speculative play.