Time to short silver?

A number of noted hedge funds and hedge fund managers have started selling. Does that mean it’s finally time to start shorting silver?

If there’s one rule I’ve learned in investing, it’s that ignoring the old saying “the trend is your friend” can lose you a whole lot of money. Stocks, bonds, currencies and commodities are all cyclical. And while I believe that the long-term trend in silver is up (reference my post yesterday: 3 reasons the rally in gold and silver prices is far from over), it’s clear that support for the white metal is breaking down in the short-term.

In part, we have the CME Group to thank for that. The Comex’s owner announced that it was raising margin requirements for the metal for the third time time in a week. As of the close of business on Monday, new initial margin requirements for silver have climbed from $14,513 to $16,200 per contract, according to BusinessWeek. Margins have risen more than 280 percent from $4,250 over the past 12 months.

The CME Group adjusts margin rates when it fears volatility in the markets could expose the company itself to losses. If metal falls too fast, for example, some traders may be unable to cover their losses – and that’s tantamount to a default that cuts into CME’s profits.

“Silver is often the lead indicator for changes in trends, or at least for corrections,” an analyst at Societe Generale SA wrote in a note to clients (per BusinessWeek). Right now, the lead indicator is pointing down.

And physical silver ETFs probably aren’t helping the situation. Stocks like iShares Silver Trust (NYSE:SLV) and the Sprott Physical Silver Trust (NYSE:PSLV) trade on exchanges just like shares in companies. They take the equity they get from investors, though, and use it to purchase physical bullion. When investors move out of the ETFs, SLV and PSLV sell bullion from their physical stockpiles.

Since ETFs are so easy to move in and out of, many investors fear they’re injected even more volatility into the already-volatile silver market. That steepens both climbs and sell-offs in the metal.

The most damming signal yet that the end may be near for silver, though, comes from a number of noted hedge funds and hedge fund managers that have started moving out of the metal. Among them? George Soros, Passport Capital’s John Burbank, Alan Fournier of Pennant Capital and Eric Sprott of Sprott Asset Management (the company that happens to manage the Sprott Physical Silver Trust).

Inflation may be imminent, but your best bet on making money might be shorting one of the world’s most popular inflationary hedges. We can logically justify why an asset should move in a particular direction, but all we know in the end is the trend. And you shouldn’t have much trouble identifying the trend if you look at silver’s recent charts.

Not sure how shorting works? Check out my post: How to short silver.

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How to short silver

When the music stops, silver prices, which are more volatile than gold, could take a drubbing. Here’s how to profit off a rapid fall in silver prices.

There’s a party right now in precious metals. Over the past 12 months, silver prices have clocked gains of more than 150 percent. When the music stops, silver prices, which are traditionally more volatile than gold, could take a drubbing. Here are some ways to make money shorting silver should investor sentiment sour on the “devil’s metal”:

1) Inverse ETNs. The simplest way to bet against silver prices is by investing in a short silver ETF. ProShares UltraShort Silver ETF (NYSE:ZSL) uses financial instruments in an attempt to return 2X the inverse of silver spot prices. If silver prices fall 1 percent, ZSL should rise 2 percent. Conversely, if silver prices rise 1 percent, ZSL should drop 2 percent. Shares in the UltraShort Silver ETF trade on the NYSE just like shares in an actual company.

2) Short the long ETFs. Don’t like being limited to a single inverse ETF? You could also profit from a silver sell-off by shorting shares in a long silver ETF. iShares Silver Trust ETF (NYSE:SLV) is hands down the most popular long silver ETF with nearly 30 million shares trading hands every day. Other popular silver ETFs include the SPDR S&P Metals and Mining (ETF) (NYSE:XME), which invests in silver mining shares, and the leveraged ProShares Ultra Silver (ETF) (NYSE:AGQ), which attempts to return 2X the spot price of silver.

3) Go long the dollar. It will take some remarkable tightening by the Fed to convince investors that the dollar’s future looks promising. If they adopt an aggressive plan to raise interest rates, silver prices will likely lose much of their support. At the same time, the dollar should strengthen against foreign currencies. In such an environment, a bullish bet on the dollar itself makes sense. Buying shares in the PowerShares U.S. Dollar Index Bullish Fund (NYSE:UUP) is equivalent to going long the USD and short the Euro, Japanese Yen, British Pound, Canadian Dollar, Swedish Krona and Swiss Franc.

4) Put options. Buying put options gives you the right to sell a stock at a specific price in the future. If you think the SLV is going to plummet by the end of May, you could buy put options that give you the right to sell shares in the ETF at a specific price – let’s say at $45. If the price of SLV falls below $45, you could go to the open market, buy the shares on the cheap, and re-sell them at the put option price. Incidentally, put options on the SLV spiked last week (per the Wall Street Journal) – an indication that investors are growing concerned about a silver sell-off.

5) Short the miners. Shorting the shares of specific silver mining companies could pay off. As the price of silver falls, so too will the profits miners reap. Silver explorers (companies that are yet to break ground on a mine) could be particularly vulnerable to a downdraft in silver prices. I’d caution, though, that you avoid shorting any company that could be subject to a buyout bid. Randy Smallwood, the CEO of Silver Wheaton Corp. (NYSE:SLW), went on the record recently predicting a wave of acquisitions when silver prices stabilize. If you’re caught shorting a company that’s bought out, your brokerage account could get cleaned out overnight.

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10 things you should know before you short a stock

Here are 10 things you must know before you short a stock. Shorting is subject to tax implications, brokerage rules and the potential for big losses. Cover your bases before you start shorting stocks, and you’ll be much happier in the long run.

This post is part of an investment series on shorting stocks titled 100 tips on how to short sell stocks.

1. Gains from short sales are taxed as ordinary income. To limit your exposure to short sale taxes, only short stocks in a tax-sheltered account or short stocks you expect to hold for a relatively long time.

2. Avoid shorting stocks in companies that are high in assets – even if they’re straddled with debt. Companies that have lots of debt and lots of assets are ripe for takeovers. Even the rumor of a takeover can push a stock up 20 percent or more in value overnight, and that could crush your short position.

3. Leave plenty of cushion in your account so that you can absorb temporary run-ups in price. Even if you’ve found a dog in the market, that dog could still take some dead cat bounces. Never risk more than 25 percent of your portfolio on a short. If the stock shoots up, you want to hold through that rise in price, so that you can watch your short position settle where it’s supposed to: near zero.

4. Short selling is subject to different margin requirements than going long on stocks. Carefully read your broker’s requirements on short margin as this could lead to the premature liquidation of your position.

5. Short selling can lead to more than 100 percent in losses (meaning you just might end up owing your broker money). Let’s say you’ve decided shorting a company with shares trading at $5 per share. If that company starts putting together a lot of big wins and the share price shoots up to $30, you’re out more than 600 percent! The moral? Have tangible reasons before you short a stock.

6. You can’t just short shares in any company. Your broker might not have the inventory to support a short position. That means all your research has went to waste. Study companies with trading volumes over 100,000 shares per day to focus your research on the companies you’ll most likely be able to short.

7. You can’t short stocks without a margin account. If you can’t trade on margin in your brokerage account, you won’t be able to short stocks. Contact your broker to apply to upgrade your account if you don’t have a margin account.

8. Short positions can lead to large losses in short periods of time. A so-called “short squeeze” happens when a stock that’s heavily shorted starts climbing. Many of the short investors who don’t have the cushion in their accounts to absorb the climb are forced to cover their shorts. This “squeeze” pushes the stock’s price up even higher.

9. Shorting a stock that pays dividends means you’re responsible for paying the dividends to the owner of the shares. You’ll receive a dividend if you’re shorting a stock when the dividend is paid, but, in turn, you’ll owe at the money to the owner of the stock who expects the dividend. This money may or may not appear temporarily appear in your trading account.

10. Put options can act as shorts. If you’re convinced the share price in a particular company will fall, you can buy a put option that gives you the right but not the obligation to sell shares in the future at a discount to the current price (so long as the value of the stock actually falls).

Shorting shares can lead to significant profits, but it can also lead to enormous losses. Be sure you fully understand the implications of shorting before you start, and make every effort to learn as much about the companies that you’re shorting as you possibly can. The more you know, the better you can protect yourself from losses, which is, after all, your No. 1 goal as an investor. You’re in it to make money, not lose money.

This post is part of an investment series on shorting stocks titled 100 tips on how to short sell stocks. Click for more tips and tricks on shorting stocks.

10 secrets to finding stocks to short

Here are 10 secrets to finding stocks to short. Shorting stocks is the art of getting ahead of irrational investors, and if you watch carefully for the signs, you should be able to do like any other investor on Wall Street.

This post is part of an investment series on shorting stocks titled 100 tips on how to short sell stocks.

1. Seek out stocks that have no intrinsic value. A stock with a $10 million market cap and $20 million in debt, for instance, or a company that’s at a competitive disadvantage in a crowded marketplace. Either would be a great stock to short.

2. Wait for a trigger that’s going to push share prices down before you short a stock. If you’re confident an overvalued stock is going to have a disappointing earnings report, wait until that report comes out and sell shares short. If strong companies in the same sector are reporting poor earnings, expect the weaker companies to report poor earnings, too, and short before the earnings release.

3. Good at reading balance sheets? Find the accounting tricks that are artificially propping up a stock. A great example of this are financial stocks that have been able to mark-to-market essentially worthless assets. Two years ago, the banks’ balance sheets looked a lot worse than they do today, but not a whole lot has changed. If the economy tanks, those accounting tricks won’t hold water.

4. Look for companies with mounting inventories. If a company’s stock-piling their wares, that means there aren’t any buyers out there. A company just can’t keep making products no one buys. Eventually, it’ll lead to price reductions, lowered margins and declining earnings. Going short before the broader market recognizes the troubles at a company are the key to locking in big profits.

5. Keep an eye out for insider sales. Inside sales are a normal part of business. If a high-level director at the company needs cash to finance a trip to Belize, he’s justified in selling some company stock. On the other hand, large, million-dollar plus sales don’t happen every day. And if there’s one thing an executive doesn’t like, it’s losing money. If they expect their company’s shares to keep going up, they’re not going to sell. They’ll be begging their uncle for a loan before they do that.

6. Seek out companies with shriveling or negative free cash flows. Companies that have taken on significant acquisition costs or R&D expenses will have lower earnings in the future. If their business model can’t support the research or acquisition, they just might not be able to climb out of the hole, and you can climb right in and make some money.

7. Short stocks in companies with obfuscated 10-Ks or 10-Qs. If a company’s struggling to keep their profits looking good, they’re going to have to come up with some nifty accounting tricks to do it. That means lots more paperwork when they file their annual reports. If you notice substantial increases in page-counts, read the fine print carefully.

8. Low-volume is your friend. If a stock’s moving up or trading sideways on low volume, investors are likely growing complacent or weary of a company. Don’t short a stock that’s climbing on high volume. You could be out of buying power faster than a fresh college grad.

9. If you’re good at shorting stocks, you can make money going long. Have a good track record of selling short? Then, you’re great at identifying when a stock is overbought. On the flip side, that means you can probably tell when a stock’s oversold. Try going long if you’ve had lots of success selling short. Just look for all the signs you avoid when you usually short a stock.

10. Short stocks that have investors in a tizzy (just make sure you wait until the party’s over). Often, a small-cap stock will release news of a huge sale that pushes a stock price up 20 percent or more. If you read the underlying news, though, the fundamentals just aren’t there. It’s not unusual to see share prices pushed up beyond values that the news justifies. For example, if a small-cap stock announces $10 million in new sales, that shouldn’t justify an intraday climb of 20 percent in market cap.

The moral? Shorting stocks is the art of getting ahead of irrational investors. If you watch carefully for the signs, you should be able to successfully short overbought stocks.

This post is part of an investment series on shorting stocks titled 100 tips on how to short sell stocks.

100 tips on how to short sell stocks

Read our guide, 100 tips on how to short sell stocks, before you enter your first short position. The more you know, the better you’ll be able to sleep at night. Our series covers everything from tips on finding stocks to short to the tax implications of selling equities short.

Short selling is a bet that a particular commodity, equity or stock will go down. If the stock or object you’re “shorting” goes down after you buy it, you sell and pocket the difference. Because markets rarely ever behave rationally, shorting stocks requires a good dose of intestinal fortitude based on tangible facts. If you’re shorting stocks without logic behind your moves, you could end up losing even more than you invested in the first place!

Short selling turns a lot of conventional wisdom on its head, and that means it requires a thorough understanding of what you stand to lose and gain. When you short a stock, for instance, you could actually lose more than 100 percent of your original investment. If you’ve shorted shares in Company XYZ at $10, and the price climbs to $21, you’re going to owe your broker money.

The more you know before you enter a short position, the better you’ll be able to sleep at night. And, you’ve come to the right place if you want to learn more about shorting stocks. We’ve put together this series titled “100 tips on how to short sell stocks.” Bookmark this page to follow us as we put together a series of posts with tips and tricks for getting the most out of your short investments.

100 tips on how to short sell stocks

1. 10 things you should know BEFORE you short a stock

2. 10 secrets to finding stocks to short

3. Three tips to make money shorting stocks