Commodity ETF Alert September 2009 Issue

October was, after all, when the crash of 1929 started.  More recently, the October 1987 correction inflicted panic and fear.  Then the market plunged almost 25% in a single day.

While October gets all the bad press, September is actually the great destructor of wealth.  Students of the stock market know just how dangerous the month of September really is.

Over the last half century, more wealth has been destroyed in September than in any other month.  In 50+ years of data, when most months are up on average, September is actually down almost 1%.

It doesn’t seem like much, but it could destroy even the most robust investment strategies.

While most new investors fear October, everyone else is closely watching September.

So, what does this have to do with commodities?

Fear in the equity markets often drives investors into commodity investments.  By moving ahead of the crowd, we can profit from the flow of funds into certain precious metals.

That brings us to our commodity recommendation for this month… Silver.

Silver occupies a very unique position among the various metal commodities.  It has a use as a store of value… perfect for times of fear or inflation.  Silver’s also used in industrial applications.  Its industrial applications make it a valuable raw material needed in times of economic expansion.

Silver prices are often driven higher by certain economic factors.  But, before we get to the economic drivers, let’s look a little more closely at this commodity.

Silver Production

Silver production varies around the world.  Right now, global production is lead by Peru, Mexico, and China.  They rank one, two, and three for total production. Occasionally, Australia moves into the top three.

Unlike gold, silver is rarely found in its pure state.  While miners can find gold flakes and nuggets, silver is found as an ore.  It needs to be mined, processed, and then smelted.

Global mine production tops 600 million ounces every year.

Here’s another interesting fact… very few pure silver mines exist.  Most silver production comes from mining other metals like lead, zinc, and copper.

In the last year, these “other industrial metals” have seen depressed prices.  Demand from manufacturers dropped and production declined.  Some mines slowed, or stopped, production as profits fell.  That’s why I’m expecting silver production to fall this year.

With less supply, prices are bound to move higher.

Silver Demand

The industrial sector is the single largest consumer of silver.  It accounts for 45% of consumption.  Silver is used in electrical controls, circuit boards, and even batteries.

Jewelry and silverware account for another 27% of consumption.  All told, these applications eat up more than two-thirds of total production.

Some old “silver-bugs” will recall photography was also a huge end market for silver. Now with the widespread use of digital cameras, silver used in photographic processing has fallen.  But don’t worry, there are lots of other uses.

In the last 20 years, a number of mints have been issuing silver coins.

Canada has the Silver Maple Leaf, Mexico has the Libertad, and the United States makes the Silver Eagle.  All coins are made with fine .999 pure silver bullion.  Almost 200 million ounces of silver have been put into coins, and are now held by coin collectors and investors alike.

I see three drivers that will push the value of silver higher.

First is fear of a market drop.

Like scared children running home to mommy, fearful equity investors often rush to precious metals.  As I mentioned earlier, September and October are two of the worst months of the year.  Any hint of the market falling and precious metals will skyrocket.

Strangely enough, there’s a second longer term economic trend that will push silver prices higher… economic recovery.  Remember, silver is used widely in industrial applications.  As the global economy starts to recover, demand for these products will rise, driving higher demand for silver.

Finally, inflation fears will push silver higher.

One of the big problems we’ll face in the next few months is an economic recovery.

Why is that a problem?

To combat the recession, the US government flooded the globe with cheap and easy money.  They created billions and billions of US Dollars for banks and bailouts.  They’re running the printing presses non-stop.

The supply of US Dollars is through the roof.  As the economy starts to recover, all of this easy money will create inflation.  The best way to combat inflation is by investing in hard assets.  Some of the best hard assets are precious metals… and no precious metal is more affordable than silver.

Anyway you look at it, demand for silver is sure to move higher.

I think we could see silver prices trade anywhere between $20 and even $25 an ounce.  (Right now, silver’s trading for $16.25 an oz.)  That’s a 23% to 53% jump from where we’re at today! 

ABOUT SILVER

My favorite way to invest in silver is with the iShares Silver Trust (SLV) which is traded on the NYSE ARCA exchange.  SLV is set up so every share trades for about the price of an ounce of silver.  In other words, if the commodity is trading for $16.25 the trust will trade for about $16.25.

SLV is issued by Barclays Bank.  They hold physical silver in a big vault.  Your shares represent a fractional ownership in those holdings.

Silver prices are more active than other precious metals because the market is smaller.  Having a dual role as an industrial metal and a precious metal also means more investors, funds, and commercial users are involved in trading.

TECHNICALLY SPEAKING

Silver is in a very nice uptrend.  It recently crossed above the $15.75 level which was the prior high set in June.  The 50-day moving average is in an uptrend.  Another positive sign is the 20-day moving average crossing above the 50-day.  Lots of positive points on this chart.

 WHAT TO DO NOW:

The iShares Silver Trust (SLV) is trading at $16.15.
Buy SLV up to $17.00 per share.
Our Profit Target is $25.00.
Don’t forget your position sizing.

ENERGY COMMODITIES

Our recommendation last month was Natural Gas (GAZ).  We’re still below the buy up to price, so if you haven’t established a position, there’s still time.

Nat Gas prices fell a bit as inventory data continued showing record levels in storage. Remember, this is a longer term trade so hold tight… I’m expecting a turnaround.

The spread between oil and gas prices is trading at record levels.  Historically, the spread averaged around 8 to 1.  Right now the spread is over 24 to 1.  I’m expecting Nat Gas prices to rise moving the spread closer to historical averages.

Oil prices (and most of the energy complex) continue to jump around like Mexican jumping beans.  The combination of regulatory crackdowns and fluctuating demand expectations are tossing prices about.

Not helping matters is the decision by PowerShares to shut down their popular double long OIL ETF.  The reason – The CFTC is telling the MERC and other markets to limit holdings by investors.  This fund was one of the largest commodity funds in the US. Now the fund is liquidating… the pressure on oil prices will be noticeable.

Our other energy trade – Oil – has stabilized a bit.  I still think $80 a barrel for light sweet crude isn’t too far off.  Remember, our price target on the OIL ETF is $27.

GRAIN COMMODITIES

Grain prices fell almost 10% in the last month.  We’re into harvest season and prices are volatile.  Problems with a late harvest might cause prices to rise.  The concern is an early frost might damage parts of the Soybean crop reducing yields.  However, if the weather holds, we could see prices fall further as yields expand.

US traders are noticing increased demand out of China for soybean oilseed products. Problems with the Brazil and Argentina harvests reduced exports to China.  This hasn’t moved prices in a big way, but it’s something to watch.

INDUSTRIAL METALS

Rio Tinto (RTP), a major global mining firm, recently announced the market outlook is improving.  This helped provide stability to the industrial metals complex.  Rio noted rising demand from China and an economic recovery are boosting overall demand.

Steel prices are reaching 10 month highs.  Yet another sign the economy is improving.
Our Copper trade keeps slugging away (we’re near 11 month highs).  JJC hit a high of over $41 giving us a 41% gain.  Hold tight as the economy resumes growing.  Home sales moved higher in July.  Copper’s used extensively in new home construction, so demand and prices are sure to move higher.

News this month out of China was shocking to some – old hat to us.  China’s been buying up nickel mining companies around the globe!  We called the move in Nickel prices two months ago and made a quick 48%.

PRECIOUS METALS

Precious metals are working their way higher.  Gold approached the $1,000 an oz. level just a few days ago on inflation fears.  This is one of the few commodity complexes to show a positive move last month.

We’re establishing another position in the precious metals space.  This month’s trade is Silver – see page 5 for more details.

Our Gold trade with IAU is now showing a small profit.  I still think we’ll see a big move higher as inflation becomes a hot-potato issue.

SOFTS

The monsoon… or lack of monsoon in India pushed Sugar prices to a 30 year high.  The monsoons returned to India in late August easing the pressure on food staples. However, the damage is done… few expect prices to return to normal.

Rice was also hurt by the lack of monsoon rains.  The last time we saw potential shortages, countries all throughout Asia started hoarding Rice.  All that did was drive prices even higher.

LIVESTOCK

Livestock prices continue to hover at the lows this month.  It’s ugly.  In our Portfolio Update two weeks ago, we told everyone to exit the COW trade to conserve capital. Smart move as prices fell further.

The downward move in Pork prices continues despite government pledges to buy $121 million for food-assistance programs.  The number of pigs being processed every year is around 115 million…

• This month we’re adding Silver (SLV) to the portfolio.  See page 5 for all the details.
• Just a reminder, we said “Sell” Livestock (COW) in our Portfolio Update two weeks ago.  If you haven’t already, sell COW now to conserve capital.
• We’re above the buy-up-to price on Gold (IAU) – we’re moving it to a “Hold”.

Category: Commodity Trading