Thursday, August 11, 2011

Silver bubble? Or ground floor? (Part I)

There is speculation in a few circles that precious metals such as silver and gold are in a bubble right now.  Such conversations in the mainstream financial press seem designed to scare individual investors from participating in purchasing bullion.

I do not think silver is in a bubble and cannot find convincing arguments in the press or the data that would support such a conclusion.

I want to summarize in three blog posts, what I see from the silver-as-a-bubble crowd first, then describe hallmarks of a bubble, then finally show where silver bullion is in relation to objective standards that typify bubbles.  Lastly I will describe something I believe to be in a bubble right now, but it ain't bullion.


 Part I:  Why the Financial Media freaks people out about silver.  

Buy more funds.   Buy more now.  Buy more funds, and be happy.  

The most immediate problem I have with the financial media's apparent take on what to buy is advertising biasThis is a powerful market force.

Most people read up on investment options and look for advice by reading/watching the financial press and related online sites.  Financial media in turn earn a lot of their revenue from companies who advertise, companies that make their money by selling investors mutual funds, credit cards, bank products and so forth and charging investors fees.  For example, each invested dollar usually that goes into some kind of mutual fund is levied annual management fees.  If a fund has $100 million dollars in invested assets and charges 1.5% per year for management, they will earn $1.5 million for management of the fund.

With this kind of fee revenue at stake, competition for investment dollars is fierce.  Think about all the ads you see for E*Trade, Fidelity, Pacific Life, whatever.. if this is how hard they work against each other for your attention, do you think this industry as a group is going to be kind to any press that offer serious alternatives to the stock and fund investment scheme?  If you buy a bar of silver and hold it in your house, well, that doesn't earn them any management fee revenue.

The same rationale is also why you see a lot of discussion about the 'safety' and 'diversification' aspects of mutual funds vs. individual stocks.  Press about individual stocks seem to skew towards emotional or momentum styles that are mysterious and frightful (think "Mad Money" with Jim Cramer).

But if you decide to buy a stock and then hold it, they don't earn any residual annual management fee income as they would if you purchased a mutual fund.  In this case they need to get you thinking about buying and selling frequently to trigger more fee revenue in the form of trading commissions.  This is why several times a day there are headlines that scream towards fear factor:
"Is it time for investors to buy?"
"Is it time for investors to sell?"
"Should investors panic?"
... and so forth.  
They want you to market time (or try), to move in and out quickly, to leave you with the impression that this is how all the big boys do it downtown and make all the big dough.  Most who try fail quietly.  But the marketing continues!  Ever hear of the pitch...
"make xzy number of trades in a quarter and qualify for a low low! LOW! commission fee per trade!"
But here's a hint:  when sailing your boat you only tack for very good reasons.  Not every wave needs active navigation.

The only thing they are missing are the sounds of Vegas slot machines when you actually buy or sell a stock. 

There be pirates in your living room.

Another clear example of an argument they make against purchasing bullion concerns supposed risk and costs of holding bullion.  Usually this takes the form of apparently sage advice instructing the reader that they have increased risk of home theft and loss if they hold bullion at home, or ominously warn about high storage costs if they hold it in a safe deposit box.

This doesn't quite hold water for several reasons.

Number one, every investment has risks.  How many people lost a lot of real dollars from the Great Recession via decimation of their portfolios, often by these same 'objective' fund money managers?  How many of us know friends and family who have had their accounts or cards hacked or stolen for illicit use?  Even those of us who put money in a plain checking account or CD lost money, because savings rates fell to near-zero and inflation went much higher;  the purchasing power of those accounts has eroded by at least 12% in just four years alone, and savings rates are not going to go up anytime soon

Second, bullion itself is quite dense, small, and easily hidden if you know what you are doing and just put a little common sense into the stashing.  Thieves breaking into your house (hopefully this never happens!) aren't going to search every crevice looking for bullion;  likely, they are after your TV, computer, jewelry or loose cash.  And most insurance companies cover you up to certain amounts of bullion anyway, or have cheap riders. 

If cost is your only consideration... storage of bullion is probably as cheap or cheaper than your money manager.

Many people already have bank accounts that qualify them for free or reduced price safe deposit boxes.  Even the cost of a full price box is only a few dollars per month, and can store considerable amounts of bullion because it is so small and dense.

Look at relative costs. Assume you have 500 ounces of silver in a safe deposit box.  At present prices of around $38 per ounce, and a safe deposit box annual fee of $50, you would have an effective expense ratio of $50 / ($38 x 500) = 0.26%.

Now compare this cost and expense ratio with a mutual fund.  Assume a 1.00% annual expense ratio (which is low for an actively managed fund):  $19,000 x 1.00% = $190 per year.  As a flat annual expense it will cost you nearly 4x more to 'store' your money with a fund company.

There are other factors as well with mutual funds, I know.  But I am pointing this out because it is the financial press that constantly brings up the cost issues involved with storing silver to discourage active investment.  So all I am doing here is putting that cost into context and showing you that their fee options on an invested per-dollar basis are actually much higher. 

Plus as an added benefit you would probably still have room in your safe deposit box left over for other important documents, such as back up ID copies, birth certificates, insurance paperwork, jewelry, and the like. 

And for god's sake, if you have bullion and roommates, just pay for a freakin' safe deposit box. 

In Part II I'm going to write more specifically how to detect a bubble generally, and specific attributes of bubble-talk as they relate to silver bullion. But the above is important because it is integral to why people misread bubbles.

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