Should You Still Be Betting on High-Growth Silver Plays?

[Editor’s Note: While silver has seen significant price appreciation in recent months, that rally isn’t reason to stay away from buying this precious metal. In fact, the professionals are still betting on silver rallies right now – even as the financial press fears the consequences of increased commodity exchange margin requirements.

Our resident commodity expert, Alan Knuckman, chimes in with his thoughts on squeezing out additional gains from silver right now…]

The November stall in stocks has not negatively impacted the metal complex, which is on the way to new highs once again. The rally in gold and silver is especially impressive against the headwinds of the dollar.

Remember how metal prices earlier this year maintained power even at the U.S. Dollar index highs in June? That’s a true sign of internal strength.

Fundamentals are supportive as well for higher prices with demand for investment grade silver coins filling a void as gold may be out pricing itself for some. At $27 an ounce a whole bunch of these anti-currency chips are affordable for most everybody who seeks safety in real monetary value. Plus the numismatic angle (interject that word into the holiday dinner to impress family and friends) dwarfs the meltdown monies of coins at this time.

This from the Financial Times:

Silver coins are selling at a record pace as investors – especially in the US – seek to limit their exposure to the dollar. The world’s top mints have seen their silver coin sales jump to record or near-record levels, and they and coin dealers are working overtime to meet the surge in demand from investors…

While the price of gold is now well above the nominal record it touched in 1980, silver remains below the $50 an ounce it hit that year. Dealers said investors were buying silver in expectation that the so-called “poor man’s gold” could soar in price.

…The interest is primarily from retail investors, [but] private bank clients and sovereign wealth funds have begun to increase investing in silver, bankers said. Although prices are largely driven by investor sentiment, silver – unlike gold – is also being helped by buoyant industrial demand.”

This heightened silver interest forced Agora Financial’s 5 Min. Forecast to call on me to clarify a reader’s concern about a recent climb in trading requirements at the exchange.

Hopefully I address both sides of the coin… so to speak:

Question: “I noticed your comments,” a reader writes, “about recent drops in the price of gold and silver partly due to recent increases in the margins by the Chicago Mercantile Exchange.

“Could you please explain whether there are any laws and regulations regarding when and how much these exchanges can increase their margins (fees), or are they allowed to manipulate the prices of the markets whenever they want?

“Please also comment whether the above significantly changes your views on the future of silver, gold and other commodity prices.”

My Response: Trading futures/commodities outright is a leveraged play with theoretically unlimited risk. The gains and losses occur at a fast rate because of the approximately 20-to-1 deposit requirements versus paying the full cash value.

To trade a gold contract, long or short, the deposit is over $6,000 with a cash value on the 100 ounces today at $134,000. That upfront cash would be enough to pay for nearly a 5% one-day move in gold before putting the account in negative territory.

Unlike stocks, that ‘margin’ is not borrowed funds, but an actual cash deposit. The amount of margin you need to put up is a function of volatility. As individual markets get more or less active and the total daily dollar amount moves, a change in the deposit may be required. It is infrequent, not even a month- to-month occurrence, but sometimes necessary for protection if the cash value of the contract has significantly increased.

The exchange wants the margin to be low enough to ensure liquidity and, therefore, efficient trade execution for all sides. At the same time, the deposit has to be large enough to protect counterparties when large moves occur.

I have found over my 20-year career that when the margin requirements are increased, it doesn’t impact the traders on the right side of the market — only those who are undercapitalized when the trade is going against them. Either they put up more money or get out.

The exchange has no vested interest in the markets moving up or down as they make money on a small transaction fee per trade.

But leveraged, high-risk plays aren’t the only way to trade commodities. In fact, the recommendations that I give my Resource Trader Alert readers are strictly limited-risk options plays where the maximum financial exposure is the premium paid.

The bottom line is this: while risk-averse investors are staying away from precious metals right now, the professionals aren’t. In fact, I’m still monitoring the metals market for a price set-up that I like. I’ll be sticking with the same strategy that led my readers to multiple metals gains in the past 12 months.

Don’t eschew silver just because it’s seen shares rise in 2010. You may be leaving potential profits on the table…

It all comes back to commodities,
Alan Knuckman
Penny Sleuth

December 2, 2010

Should You Still Be Betting on High-Growth Silver Plays? was originally featured in the Penny Sleuth. Check out Wall Street’s 5 Most Profitable Penny Stock Patterns Report.

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