Why the GFMS believes silver will rally after June

Higher silver prices look likely later in the year. Beware of painful bumps before we get there, though.

Despite weakness in the silver market, a leading London-based precious metals consultancy believes we’re setting up to see a spike in silver prices during the second half of 2012.

“Prices are probably going to head higher [in the second half of 2012] and we could see a push above $40 at some point,” though silver is unlikely to sustain those price levels Philip Klapwijk, the Global Head of Metals Analytics at Thomson Reuters GFMS, told Dow Jones Newswires last week. “I don’t think silver has the same get up and go that it did last year.”

Still, Klapwijk intimated that new monetary stimulus from the Fed could lead to a spike in gold and silver prices, and he believes that stimulus is likely in the summer or early fall.

Before that time comes, though, there could be pain. And if gold prices drop below $1,600 an ounce, silver prices could be susceptible to a price plunge.

GFMS, nonetheless, believes monetary stimulus will help silver will sprint higher in 2012. On top of that, they believe industrial demand for silver is strengthening, Klapwijk told Dow Jones. The extreme sell-off in silver late in 2011, probably lead manufacturers to deplete their silver stocks last winter. Those stocks need replenished, and they’ll need replenished this year.

In a separate interview with Kitco News, Klapwijk said he expects silver to trade between a low of $29 an ounce and a high of $42 an ounce.

Investors should also keep an eye on the gold-silver ratio, Klapwijk says. Currently, the ratio stands at 52. GFMS believes it could head higher (as silver weakens), perhaps touching 55. Historically, the ratio has stood around 53:1, but when silver prices warm up later in the year, Klapwijk believes the ratio could fall as low as 45:1.

Not everyone’s so optimistic, though. Steady erosion in the trading volumes for the iShares Silver Trust ETF (NYSE:SLV) has at least one writer arguing that we’re on the cusp of “a reckless close-out” in silver prices.

“(The selloff could be) without precedent in the history of this ETF and perhaps ever in the history of the modern silver trade (though don’t hold us to that),” writes Hugh L. O’Haynew at OakshireFinancial.

Even Citigroup’s gotten in on the action. Last week, they predicted silver prices as low as $27 an ounce by the end of 2013 (check out our post Why Citi says investors should stay away from silver for more).

Gloomy stuff. And a reminder that we shouldn’t over-leverage our bets on any commodity. If you do think silver’s going down, though, there are ways to profit off the decline. One of our favorites is the ProShares UltraShort Silver ETF (NYSE:ZSL). The ETF looks to return twice the inverse of the silver spot price. That means if silver goes down $1, ZSL should go up $2.

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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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How to short silver

There are several ways you can short silver to capitalize on future price declines.

Yesterday I covered “Three triggers that could push silver over $50 ounce.” I don’t think now’s a safe time to short the metal, but I’m also aware that not everyone agrees with me. If you think silver’s overbought at today’s prices, there are several ways you can short silver to capitalize on price declines:

1) Short silver mining stocks. Because silver’s price per ounce is so much lower than gold’s, silver mining stocks are more volatile than gold mining stocks. Their sensitivity to swings in the silver spot price makes could make you a lot of money in a short amount of time (conversely, it could lose you a lot of money, too). In general, you should avoid shorting silver mining stocks that are profitable. Look for thinly traded, small-cap silver mining stocks that represent exploration-stage companies. If indeed the price of silver does fall, an exploration stock will lose value faster than shares in a company that already has operational mines and some incoming capital. Be aware that shorting shares in a single mining company can be risky – particularly if that specific company gets a buyout offer or announces promising results after drilling on one of its sites.

2) Short silver ETFs or ETNs. The iShares Silver Trust ETF (NYSE:SLV) holds physical silver in vaults around the world. Because SLV is backed by actual silver, it’s one of the most popular silver trading vehicles in the world with an average of more than 22 million shares trading hands everyday. Shorting SLV will eliminate the risk associated with shorting shares in a specific mining company. Other silver ETFs or ETNs could leverage your short position. Among them: Global X Silver Miners ETF (NYSE:SIL), which invests in silver miners rather than the metal itself and ProShares Ultra Silver ETF (Public, NYSE:AGQ), which leverages a bet on silver prices by seeking to return 200 percent of the daily London delivery price for silver.

3) Buy an inverse silver ETF or ETN. The ProShares UltraShort Silver ETF (NYSE:ZSL) specifically tries to move in the opposite direction of the silver price. When you buy shares in ZSL, you’re betting that the price of silver will fall. Because ZSL is an ultrashort (meaning it’s seeking 200 percent of the inverse of the silver price), moves in the stock’s share price can be particularly powerful.

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