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The Silver Stocks Situation

By Roland Watson      Printer Friendly Version
Mar 19 2008 10:48AM

Since the August lows when silver hit just over $11 an ounce, we have seen silver surge to $21 for a rough gain of 75%. That is a very good return over 7 months or 92% if annualized. But silver investors had high hopes for another asset class when this bull run began and that was silver mining stocks.

How have silver stocks done since this 75% silver run began? Our newsletter combines 14 silver stocks into an equal weighting index called the SASC; if we use that as a representative of the silver stock universe we get the chart below (silver price in green).

The SASC hit a low of 5.08 on the 16th August 2007 with silver. Last week it was at a new bull market high of 8.07 before falling back. So the SASC gained 59% while silver gained 75%. In other words, silver is outperforming the silver stock index by 27% to the chagrin of silver equity investors! Not only are silver stocks not delivering the leverage seen in the earlier years of this silver bull but are actually underperforming silver. This is a situation not anticipated by many. After all, if a company is pulling silver out of the ground for $5, $6 or $7 an ounce, silver at $20 should see huge gains for the given stock’s price. Why the paradox, what happened to the double or triple leverage that silver stocks were getting over silver in 2004 and 2006?

As mentioned previously, increasing infrastructure costs and government interventionism have weakened the attractiveness of mining stocks but surely not to the extent that they should underperform gold and silver? The problem is that big correction in the SASC between November 2007 and January 2008 which skewed stocks against silver. Prior to that silver stocks were doing well. What happened to cause this divergence between silver and its derivative mining stocks? The answer is the general stock market. Look at the chart for the same period for the S&P500 (SASC in green).

In early January, an event of technical significance happened on the S&P500. The 50 day moving average moved below the 200 day moving average. The result was to many technical traders a signal that the S&P500 would not be rocketing upwards anytime soon. The sell off ensued and mid to low cap silver mining companies suffered along with them. Note that this crossing of the two moving averages last happened in October 2000 with dire consequences for the S&P500!

Only now do silver stocks seem to be recovering while stocks in general either drop further or meander. So have silver stocks shaken off the stock market connection and finally got on track with silver? I am not sure which is why silver investors should always have additional money put into physical bullion, ETFs or allocation programs.

What I think we need to see here is a stock market rally to help boost any silver stock surge. If silver and the general stock market are moving upwards then we have the best of both worlds for silver mining stocks and they will outperform silver. The Elliott wave pattern of the S&P500 down move since October 2007 suggests a rally is on the cards, so we anticipate silver stocks will ride that move up profitably.

However, once silver makes its major top in the next few months, will that also signal the end for the silver stock bull as well? The answer is most likely yes since our SASC index has tracked the silver ups and downs fairly well since 2003. In other words, a silver top should also signal an exit for silver stock holders as well. Note that individual silver stocks will have their own price patterns which may top out before or after silver.

But there is one situation which may negate this and we will cover that in the next part of this examination of silver stocks versus silver.

Roland Watson



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