Silver and the bubble curve: where is the Smart Money heading? (Clue: it ain't silver...)

This post will make me about as popular as a fart in a spacesuit, I know. Certainly the PM blogosphere will react with a mix of mockery and vicious hatred. And even my esteemed fellow contributors at Screwtapes will probably run out of eyebrows to raise at what follows.

But I don’t care. There is so much nonsense talked about the PM markets on the web, and so many people are being unwittingly dragged into cult-like devotion to lumps of metal they think will make them millionaires, that I believe it’s becoming ever more important to present every possible side of the case.

So here’s an article about how silver is not the only fruit, and anyone whose sensibilities this offends can b(l)og off and instead read the latest spittle-flecked pant scrapings from SGS (which will no doubt be about Blythe destroying nuclear power plants in Japan at the request of Mossad, or – the new comment section favourite – aliens hoping to steal silver from the COMEX).


Bubble curves and the ‘Smart Money’

Most PM investors are familiar with this kind of
graph, not least because it is touted all over the place as a way of supporting the assertion that silver was not in a mania last year, and will not be in a mania if the price doubles (or triples) this year. Now is the time that the ‘Smart Money’ should enter, so we’re told.

This is not new: in April last year, the Blogosphere buy screams were deafening at $47, cautioning their readers against missing the boat to $250 – 500. The Smart Money should get in immediately they said. They’re beginning to say the same thing again, with silver at $29. Now don’t get me wrong: I doubt I could be more bullish on silver at the moment. I have a nice stash bought at $27 which I’m very much looking forward to selling at between $38 – 42. Claims that Screwtapes contributors are ‘perma bears’ couldn’t be further from the truth.

But the silver chart has nothing of the Smart Money about it. Real silver bears would say that actually we’re between the ‘Return to normal’ and ‘Fear’ stages. I personally don’t agree with this (QE, and its effects on commodity prices, the continuing push for a mania in the tiny community that is silver, and the fact that silver is not currently too far from its trend line suggest otherwise). However, at best – I mean, in the most positive possible interpretation – we are somewhere in the Mania phase.

I’ll repeat: this does not mean that silver won’t now rise (possibly quite dramatically) for the next few months. I think it will, and I hope to profit from it. But Smart Money it ain’t.


So where should Smart Money go now?

Imagine I’m a greedy investor (I am). I don’t want a x2 or (very optimistically) a x3 return from what’s left of the silver mania in 2012. I want a x10 or a x20. Like the clever swine who bought silver at $5 back in 2003. So where is the Smart Money going at the moment? First, let us examine the qualities which potential investments should have in order to be considered Smart Money.

1) The vehicle (stock, bond, commodity, whatever) should have been in a lull (i.e. stagnant) for a considerable period of time. Like gold was between 1998 and 2002 (range: around $270 - 350) or silver between 2000 and 2004 (range: $4 – 6).

2) It will thus have been written off by all pundits. The price gets so low that no-one will sell. But new buyers aren’t drawn in because of the perceived opportunity cost of having their money sat stagnant in a non-performing asset. Like silver in 2003.

3) The vehicle is, however, sound. In other words it is not a company facing bankruptcy or a commodity or good that no-one will ever need again. The business is still profitable (perhaps only just) or the country (referring to bonds, here) is still solvent (also perhaps only just). In the case of silver, it was always going to be valued for jewellery and industrial uses and by ‘eccentric’ retail investors, so there would always be some support to prevent the price dipping (much) further or – in the worst case scenario – to zero.

4) There are clear upside events on the horizon, which – once they take hold – will bring in new buyers, and potentially very quickly. Using gold as an example, we could have said that the Smart Money buying at $280 was anticipating currency devaluation, Middle East crises/oil shocks, whatever. The point is that although the Smart Money did not know the timescale, it knew (or hoped) it would happen. These people are now getting seriously paid (and, in some cases, doing the selling...)

So what assets are there currently floating around that look like they fit these criteria?


Enter stage left, the bank stocks

Boo, hiss, shame!, get out of town, you fully paid-up bankster shill...! We always knew you were a JPM hack...! I bet Blythe sticks [insert large object of choice] into your [insert orifice of choice] and you [insert degree of pleasure of choice] it.

Now that’s out of the way, let’s have an objective look at the situation. I’m going to use the example of Lloyds-TSB (LON:LLOY), simply because it’s a UK company so I’m familiar with it and the back story, and have some experience from trading it for a while. But I’ll make my disclosure right here: I’m long Lloyds-TSB (and RBS and a few other banks) and I hope to initiate new positions in the next few months. However, I receive no payment from, or have any kind of professional relationship with, any bank (which is a shame, because it would mean I could stop wasting my time blogging and finally land that foxy Brazilian lingerie model of which I’ve always dreamt).

Lloyds-TSB, like many banks, lost most of its value post-2008. In fact, it went from 591 BPC (British Pence) in 2007 to a low of 21.84 BPC in November 2011. In short, it has been in a period of decline/stagnation for over three years (criterion 1). Its chart sure looks like the Smart Money part of our bubble curve:



The overwhelming popular sentiment is that Lloyds-TSB (and I again stress, I could've picked many other banks here - the use of Lloyds-TSB is merely illustrative) is going nowhere, and that the shares will not recover. However, no-one's selling their shares because, frankly, if you had a position at 590 BPC, you’re unlikely to sell just because the price has shifted from 22 to 24 BPC in daily fluctuations. If you’ve held through all the trauma to date, you’re about as strong a hand as one can imagine (criterion 2).

Lloyds, however, is not bankrupt. Sure, they’re not the money-sucking machine that they once were, and they’ve had a few years of losses, but it looks like 2012 will be the first year since the crash that they declare a profit. Their customer base (on the high-street banking side) is as strong as it ever was, and their efforts to recapitalise have been successful. Their exposure to foreign debt is not great (and has, in any case, been insulated against by their recapitalisations and UK government protections). So, on criterion 3, it’s looking pretty good too.

[An aside: There are always those who will say that the Western banking model is dead, and that the shares will go to zero. Maybe they’re right. But my response to this is that if the UK’s largest banks go bust, then we’ll be so royally [insert expletive] that the best we can hope for is a life of trading acorns and eating our grandmothers and less-favoured children. Good luck buying tinned bacon with your silver in such circumstances: all that awaits a genuine apocalyptic financial meltdown in the US/Europe is death, destruction and chaos. Your PMs will either stay in your possession for approximately a femtosecond or live out their days buried in whatever forest in Montana or Wales you left them. Regardless, the loss of your investment in banking shares will be the least of your problems.]

Now, back to reality, 2012 is likely to see a dividend paid (again, for the first time since 2008) by Lloyds-TSB. And, as mentioned above, its first profit announcement since 2008. Even more important is the fact that the UK government has a 43% stake in the company, at an average of 74 BPC per share acquired during the part-nationalisation. This actually came about not directly because of the 2008 crash, but rather because Lloyds was heavily arm-twisted into bailing out the doomed HBOS during the crash. In any case, the UK government wants its money back. Further, it has to get its money back, as the UK faces decades of austerity if its investments in Lloyds-TSB and RBS don’t pay out. This part should appeal to those who implicate TPTB in every financial machination: the British government has a massive interest in doing whatever it takes to get the share price of Lloyds-TSB at least back up to 74 BPC. Otherwise, ‘good-bye’ ministerial cars and Yes, Prime Minister, and ‘hello’ back bench obscurity. What would you bet on? I rest the case for criterion 4.


Are we at the end of the Smart Money phase for bank stocks?

The night is always darkest before the dawn breaks, goes the old cliché. Continuing with the example of Lloyds-TSB, last year was very dark indeed. The Euro crisis hit it hard, as did the threat of extra regulation and the temporary loss of its chief executive, António Horta-Osório. All of this pushed its share price down to what feels like a bottom of 21.84 BPC. Tellingly, trading in this particular bank stock has since been exceptionally volume-heavy: investors are piling in. It’s risen nearly 50% since then (from 21.83 to 29.97; cf. silver’s move of $32 – $26 – $29 during the same period), and shows no sign of abatement even in the face of potentially very bad news. On Friday, when the news of France’s downgrade was announced, it dipped in line with the rest of the FTSE, and then surged on new buying to finish nearly 3% up on the day.

Why should this be? My theory – and I accept that it is only a theory – is that we are nearing the end of a Smart Money phase in some bank stocks. Those banks that remain profitable and relatively insulated against further risks, and for which most risk has already been priced in, seem to have very little further downside and a hell of a lot of upside. For silver to make a x10 return, it needs to go to $300 an ounce. For Lloyds-TSB to do the same, it needs to go to 220 BPC a share.

It all comes down to which you think is more likely in the next three – five years: $300 silver to achieve six times its best ever price, or Lloyds to claw its way back to one-third of its pre-2008 price. I know there are many who read this site who would say, “that’s easy – silver every time”. Fine. I have silver too, and will be happy with that. But a good investor is a hedged investor, and is also a realistic one. And, for now, I expect TPTB to look after their own interests and restore value to their directors’ shares far more quickly than they will enable silver investors to reap massive rewards.


FULL DISCLOSURE: Long LON:LLOY and LON:RBS and physical silver and physical gold. New positions in each of these are likely to be taken throughout 2012.

12 comments:

Robert LeRoy Parker said...

Japanese equities have been in a lull for twenty years similar to gold 1980-2000. Considering they may finally start outright monetization thiis year or next, maybe that's a better bet than banks.

Spicy Guacamole said...

JdA: that brazilian model link was completely uncalled for!

Pamplona said...

Interesting article and I applaud you for going against the grain, that is, after all where the money will be made. What are your opinions of the dry bulk shipping industry? Diana Shipping and Paragon Shipping have been on my watch list for 2 years now and seemed to have bottomed. Whats concerning is that while shipping rates have historically followed bulk commodities, there's been a decoupling the past year.

https://lh4.googleusercontent.com/-f3CGhi7fG-E/TxHRyCGaKaI/AAAAAAAACRY/ojGHEEPPGJA/s767/DSX.JPG

Pamplona said...

"JdA: that brazilian model link was completely uncalled for"

+1, hilarious how "Brazilian Lingerie Models" is first of the labels

Anonymous said...

@RLP - that's a very astute comment.

The point of this post was to try to identify new areas where the Smart Money might go. The problem is always - as I think you alluded to - that the 'stagnant' part of the Smart Money is uncallable. So you might have to sit for one year, or ten (or twenty in the case of Japan). And there's an opportunity cost associated with that for an unknowable period of time.

So, if we're to look for cases where the stagnation period is surely at an end, then Japanese equities must appear highly on such a wishlist.

+1

Anonymous said...

@Pamplona: That's alphabetical order for you... ;-)

GM Jenkins said...

Great stuff, JdA. Your breakdown of criteria for the "stealth phase" is very useful.

Is it true though that a collapse to zero of bank stocks necessarily signifies societal breakdown? Can't they merely be nationalized? I ask because the Austrian school argument is that they should've been allowed to fail in 2008, and most of the Austrian schoolers I know would cut sorry figures trying to lug their metals around a forest while hunting squirrels.

Warren James said...

@RLP, you're right about Japanese stocks - Bill Bonner and crew were promoting these as the 'trade of the decade' for all the same reasons, though the nuclear reactor incident gave it a bad start in 2011.

@Jeanne, nice elucidation. My bet is still that silver is also still in a smart money phase based purely on the size of the market - (even though I predict more volatility for silver in 2012) but I see no problems with your proposal (and fundamentals arguments). Add monetization of debt to the equation and it looks very good indeed.

Apparently Mike Maloney sells advice to silver investors so that they can 'get out at the top', that's where the money is - selling food at the gold rush site - getting money from people helping them not be a bag-holder. The trouble is that someone, somewhere, will be the bagholder.

Anonymous said...

@Pamplona,

Dry bulk shipping is way outside my area of expertise, I'm afraid. However, the graph you linked to certainly seems like the sort of thing we should be looking at. Essentially, something that had great value which will probably have great value again (shipping is always going to be an essential service).

However, your graph looks like a textbook bubble which has popped (I'm assuming the annotations are yours, and I broadly agree with them). In other words, this is not comparable with, say, Lloyds-TSB, which was not in a bubble before it crashed. What I'm saying is, "to where is the upside going to be?" Will it be to the pre-bubble level (i.e. a move from 8 to 16, or a double) or will the bubble reinflate (a move from 8 to 43, around a five-times increase)? As bubbles rarely reinflate so soon, relatively speaking, after they're popped, my money would have to be on the former. Especially given that Chinese commodity imports are not likely to expand at the same rate over the next decade as they did during the last.

But, like I say, I'm no expert on this!


[BTW - I can't get this reply thread thing to work at all. Anyone got any suggestions?]

Anonymous said...

@GM

"Is it true though that a collapse to zero of bank stocks necessarily signifies societal breakdown? Can't they merely be nationalized?"

A fair question. I was, of course, being a bit rhetorical when going on about acorns and grandmothers. And if, say, just Lloyds-TSB failed, then society would probably survive, and you'd have the opportunity to regret your investment in relative peace.

The problem is that such bank failures are unlikely to be isolated events, and the domino effect is a real and terrifying possibility. If four or five big European/US banks go at the same time, then the system is effectively smashed to pieces. Governments would not have the money to nationalise them, nor to compensate the ordinary savers who would lose their savings. The resulting liquidity crisis would wipe out just about every other kind of investment too.

In such a scenario, I think that effete, soft-handed Austrian school economists would indeed come to sorely regret their view that banks should be allowed to fail, as well as their lack of forest foraging and bare-knuckle street fighting experience.

Anonymous said...

Thinking more deeply about this, my argument for buying bank stocks is a variation on Pascal's Wager, viz.

If God exists, and I believe in him, I will go to heaven. If God exists and I don't believe in him, I will go to hell. If God does not exist, but I do believe in him, then I lose nothing. Therefore, I should believe in God.

Thus:

If I believe in bank stocks, and they go to the moon, I will be rich. If I do not believe in bank stocks and they go to the moon I will have missed an opportunity, but will be no worse off than before. But if bank stocks collapse, regardless of whether or not I believed in them, we will all be going to hell. Therefore I should buy bank stocks.

Anonymous said...

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HERE