Will the Fiscal Cliff Hammer Silver?

Having miraculously survived the end of days as predicted by the Mayan calendar, we are now all on the verge of going over the fiscal cliff according to Senate Majority Leader Harry Reid. Negotiations in Washington have not been running smoothly and the debt ceiling is set to be hit on Monday, Dec. 31.

Over the past month, silver, as represented by the iShares Silver Trust (NYSEMKT: SLV  ) , is down over 11%. Against the backdrop of the Federal Reserve and other major central banks pumping cash into the economy, the looming fiscal cliff, the U.S. edging toward the debt ceiling, and increasingly little time to reach a resolution, you would have thought precious metals would be running. Considering the forces at play and how to position yourself is an important exercise.

The fiscal cliff
The fiscal cliff refers to a series of scheduled tax increases and spending cuts that are slated to take effect in 2013 unless an agreement can be reached in Congress. The Congressional Budget Office has considered the impact of going over the fiscal cliff as it stands, stating that such an event will cause a deep recession and the loss of as many as 2 million jobs. The most critical three areas likely to be affected are the looming debt ceiling, the lapsing of various tax relief measures, and the first round of sequestration cuts.

As the calendar turns over, a variety of tax relief measures will end. Amongst those affected are the so-called Bush tax cuts as well as the end of the payroll tax holiday and extended unemployment benefits. Sequestration refers to mandatory spending cuts that were scheduled as a self-imposed threat by Congress if it could not find bipartisan support for some needed belt tightening; no agreement was reached so the cuts are poised to take effect.

Lastly, floating above all of the specific measures is the fact that December brings with it the threat of the U.S. again hitting the debt ceiling. In a recent letter to Congress, Treasury Secretary Geithner wrote: "'I am writing to inform you that the statutory debt limit will be reached on December 31, 2012, and to notify you that the Treasury Department will shortly begin taking certain extraordinary measures authorized by law to temporarily postpone the date that the United States would otherwise default on its legal obligations."'

Congress at work
As the days tick by, and the likelihood of a resolution seems increasingly small, silver should be expected to perform well. Economic uncertainty, like that created by a new recession, tends to favor commodities because they tend to be good stores of wealth. As inflation, global political unrest, and currency shifts affect the value of financial assets, tangible and necessary goods not only maintain their value, but rise in price as the economy works through the challenges. Silver tends to be particularly appealing because it has both intrinsic and industrial value, as is coveted for both purposes.

Under these circumstances, the question becomes how best to invest in silver. While physical silver has a certain appeal, and the dollar values involved are certainly more manageable for most investors than those involved with gold bullion, there tend to be steep commissions and spreads to the spot price that are not attractive – additionally, these must be paid again when you wish to remonetize your reserve. The ETF is a great option for most investors as it avoids some of the vagaries of the futures market, while still tracking silver performance very closely.

The final option is to invest directly in silver companies like Silver Wheaton (NYSE: SLW  ) , Pan American Silver (NASDAQ: PAAS  ) or First Majestic Silver (NYSE: AG  ) ; the Global X Silver Miners ETF (NYSEMKT: SIL  ) provides diversified access to silver miners but does not allow you to assert any preferences you may have between various options. As a silver investment, Silver Wheaton remains my top pick based on its business model and its reserves. The company is not a miner, but a silver streaming company. Rather than operate mines – that have been subject to ballooning production costs – the company contracts with miners to purchase their production at a predetermined and fixed cost. The company earns the spread between its negotiated average cost and the prevailing price of silver in the market.

Currently, Silver Wheaton has over 800 million ounces of silver reserves at an average cost of just over $4. This gives the company great exposure to silver prices, while allowing it to remain insulated against many of the challenges faced by miners. This allows the company to carry an operating margin of 74% relative to 30% for Pan American and 48% for First Majestic. While the others have very attractive margins, neither is close to that offered by Silver Wheaton.

A soft landing
The probable scenario is that if a resolution is reached, silver prices will dip on the news. This would favor a wait-and-see approach if you believe Congress will ultimately step up. The details of the resolution are critical to understand as well. While a long-term solution may see silver prices continue to fall as the economy recovers, a solution which simply delays the issue could cast the U.S. economy in an even more negative light, driving silver prices up.

Ultimately, while it may be the slightest bit too soon to jump into silver, all signs point to the U.S. going over the fiscal cliff. With the Fed ignoring inflation – which is to say, doing everything it can think of to drive inflation – commodities have a bright longer-term outlook. In the simplest terms, there is limited downside left in silver, and I'm a buyer, even ahead of the last minute deal we are all hoping for from Congress.

If you are looking for a company whose success is determined by the metals market, but without involving itself in the risks of physically mining the metals, then Silver Wheaton provides a unique play on the future of silver. SLW chooses to finance the mining of silver; it has grown sales and net income every year since 2008, and also has increased competitive advantages over its limited peer group. More details about our outlook for Silver Wheaton can be found here in our Motley Fool analyst report.



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  • Report this Comment On December 28, 2012, at 2:39 AM, JimWherry1 wrote:

    This is the only commentator who has suggested going over the Fiscal Cliff would be good for Silver and that resolving it will be a down side for Silver.

    Here's why he's wrong:

    1. The CBO and every economic commentator predicts that the Fiscal Cliff will bring on a recession. That's reasonable because we're propping this economy up on a credit card, anyway. Recessions are BAD for precious metals. PM's thrive on inflation and a falling dollar. Lower budget deficits actually strengthen the collar and recessions cut inflation. Right now, the Fed is doing everything possible to block inflation, anyway.

    2. Silver and Gold have been following the stock market, lately. Some would suggest the Fed's actions have "monetized" these two commodities so that they act like stocks. And, really, ETF's do just that, so is there really a surprise?

    3. If the Fiscal Cliff is not resolved, STOCKS will also plunge, and that means a great buying opportunity. If you don't have a pile of cash laying around, what do you do to raise cash? Sell hard assets like Silver and Gold.

    4. Right now, Elliott Wave analysis suggests we're up for a plunge to around $26, or worse.

    In short: the Fiscal Cliff is BAD for Silver, but great, if you're shorting it - which I am. Once the play is made, Silver at $26 or below may become a terrific Call, but BEWARE of the coming recession (or, beware the recession that never left us).

  • Report this Comment On December 31, 2012, at 4:02 PM, StockAnalytical wrote:

    Everything points to Silver prices strengthening regardless of the Fiscal Cliff that the US unfortunately went over some time ago - the issue now is not to drown in the waters below and somehow climb back up.

    Above ground reserves of Silver are getting close to depletion with barely a year's supply now in stock.

    When real investment in Silver is taken to account, rather than the annual "implied investment" as a balancing item, a shortage of Silver will be evident in around three years and then forward.

    Thanks to the market shorters, Chinese interests continue to build up long positions.

    Chinese "investment" in Silver (rather than industrial use of), continues to grow substantially. Just at the government level, minting of the Silver Panda is mandated to produce 45 -50 million ounce coins a year - up from 600,000 just a few years ago.

    Industrial use continues to grow and mine production is not growing at the same pace - this is why the above ground reserves have depleted from around 15 years worth to current levels.

    Even the big players are working hard at reducing their massive short positions. Last week's industry Commitment of Traders (COT) Report was revealing - the net short position declined by 43 million ozs for the week to 239 million ozs. JP Morgan still holds 150 million ozs of this, followed by the Bank of Nova Scotia with the rest of the market only in at 39 million ozs. These numbers clearly show that the market is not governed by sentiment or even demand at this point, but rather by a couple of major players working the market and trying to cover.

    2013 will be an interesting year for Solver - early on in the first Quarter, we are looking at a solid rise - so if short then be WARY, the China and many others are loving it.

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