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January 18, 2008

Real Silver Highs 2
by Adam Hamilton

Gold is definitely not the only commodity enjoying a very happy new year. The strong global investment demand for precious metals has spilled over into silver as well. Just last week, silver soared above $16 for the first time since January 1981! Silver investors are naturally very excited about this dazzling 27-year high.

I am very thankful to be one of the early investors in this secular bull. Silver's bear-market bottom was carved in November 2001 just over $4. That very month I started formally recommending silver bullion as a long-term investment to our newsletter subscribers. Soon after in early 2002 I started investing and speculating in silver stocks. Over the years since, we've been blessed with many awesome realized and unrealized gains in this silver realm.

But silver's manic-depressive bull sure hasn't been easy to trade. The metal's mighty parabolic surges are the stuff of market legend. If you are long the silver complex when they happen, you will make a fortune. But between these rare hyper-exciting episodes, the vast majority of the time this metal generally grinds along sideways in seemingly endless consolidations. Few other sectors are as psychologically challenging to traders.

So as I pondered silver's highs this week, it feels like a dear old friend prone to extreme bipolar mood swings. After its long gloomy consolidation since May 2006, it is great to see some excitement return to silver again. I wanted to write about silver's breakout success this week, so I was weighing several different threads of silver research to pursue. And then the new CPI numbers made up my mind.

The US Consumer Price Index for December was released this week. Despite its flawed design which perpetually understates true monetary inflation, the CPI's full-year 2007 results were stunning. It was up 4.1% last year, its biggest annual surge since 1990's 6.1% jump. With even the Pollyannaish government propagandists running the BLS now acknowledging serious inflation, I thought it would be interesting to revisit my studies on inflation-adjusted silver prices.

While inflation doesn't affect silver prices all that much over the short term, over the long term its impact is enormous. Any long-term analysis of silver that doesn't consider the relentless slide of the US dollar's purchasing power will radically distort the results. In real inflation-adjusted terms, silver is nowhere near as high today as its headline nominal price implies.

If looking at asset prices through the lens of inflation is new to you, please read my latest essay on real gold highs to gain more background perspective. The purchasing power of a dollar today is considerably less than even a single decade ago and almost catastrophically less than several decades ago. Long-term charts that don't acknowledge this inflation end up being nonsensical apples-to-oranges comparisons.

These charts this week show the usual headline nominal silver price in red. Superimposed on top of this is the real inflation-adjusted silver price in blue, along with a couple key moving averages tied to it. The universally-accepted CPI, despite its many flaws, is used to calculate these real prices. This is very conservative compared to true monetary inflation since the CPI considerably lowballs historical real silver levels.

Since the cumulative effects of inflation build dramatically the farther into the past we delve, we'll start in the present and work back. Adjusted for inflation as of this week's new December CPI report, real silver isn't much different from nominal silver over the span of this bull. In today's dollars, silver bottomed much closer to $5 than $4, but otherwise its bull-market journey hasn't been materially different.

With inflation not particularly relevant over this relatively short span of time, we can briefly digress into silver's technicals. The metal's new bull high this week is readily apparent, as it finally broke above the real $15 resistance level plaguing it since May 2006. And while silver certainly rose nicely on balance to soar from $4 to $16, its peculiarities made for a very challenging ride.

In the early 2000s, silver largely just ground sideways despite the new bull market in gold. This sorely vexed the hardcore silver faithful. By the time silver finally started moving higher in earnest, gold was already up over 50%. This multi-year episode perfectly illustrates silver's long tendency to lag gold. I recently researched silver lagging gold and it is readily apparent all throughout modern history.

Gold dominates the overall precious-metals psychology. When gold is up, speculators start getting interested in silver too. And if gold stays strong for long enough, silver futures traders will start getting really excited and rapidly bid up silver into one of its famous parabolas. Silver is such a tiny market compared to gold, so it doesn't take a lot of capital to drive the white metal parabolic after the yellow metal has generated enough bullish psychology.

And indeed these periodic parabolas really define our silver bull to date. Almost all of silver's gains since late 2001 happened in just two very fast parabolic surges. The great majority of the time in this bull, silver was merely grinding sideways in long consolidations after its parabolas crashed. Even though its support slowly rose in both major consolidations so far, these still really tried the patience of silver traders.

So realize if you want to invest and speculate in silver that it is a peculiar metal. Much of the time you own it, you'll be bored to tears or frustrated enough to scream. But if you stay long until the next silver parabola inevitably arrives, probably near the end of our current gold upleg, you should win enormous profits. Silver offers massive gains, but just not very often. So its traders need to cultivate the patience of Job.

Once we get back a couple decades, the divergence of real silver from nominal silver becomes readily apparent. In today's 2007 dollars, silver is really just at a 21-year high. You have to go back to another parabolic silver spike in early 1987 to find real silver prices above today's levels. While a 21-year high is nothing to sneeze at, it certainly makes today's highs look a lot less extreme than a 27-year nominal high implies.

Interestingly, in real terms the late-2001 dividing line between secular bear and secular bull is much clearer. While nominal silver was grinding under $4 to dismal lows in the early 1990s, once you render it in today's dollars silver remained well above its late-2001 bear low. And since that low, note how extreme silver's two parabolic surges of this bull look on this chart scale. When silver finally decides to move and reward its longsuffering traders, it rockets up fast.

Moving back to early 1998, the Warren Buffett silver spike looms large. The legendary investor had purchased 130m ounces of silver in 1997 for 1998 delivery. Like any smart large trader he didn't telegraph his purchase immediately, but it became known when Berkshire Hathaway started discussing its 1997 investments. Silver speculators rushed to buy the metal on this news and it instantly soared in another parabolic ascent. It led to the highest real levels seen between 1989 and 2005.

Mr. Buffett ended up selling his silver, and years later joked "I bought it very early, I sold it very early. Other than that it was perfect." But the incredible effect the mere reports of his buying had on silver is very illustrative. Since silver is such a relatively tiny market, any factor that drives big sudden buying is going to generate vertical price increases. This is why it is very important to be long silver late in gold uplegs when traders start to get really excited about precious metals.

In these charts I marked silver's seven major highs of the last four decades with yellow numbers, and Buffett's silver spike happens to be the sixth. At each of these major secular highs the real and nominal silver prices are noted. The farther back in time we travel, the greater the cumulative effects of the Federal Reserve's endless inflation and the greater the real/nominal gap balloons.

This four-decade chart is the whole enchilada, silver's entire modern history. If you want to know what silver traders dream about, this metal's legendary parabola of late 1979 is it. I have yet to come across a more extreme parabolic ascent in all my studies of market history. Silver's all-time-high close of $48 on January 21st, 1980 translates into a mind-blowing $130 in today's dollars!

I'll dig deeper into this super parabola below, so let's concentrate on the big picture for now. First, note that all of silver's major uplegs in modern history are parabolic ascents. While silver doesn't move big very often, when it does it moves awfully fast. Between these incredibly profitable vertical surges though, silver tends to merely grind along with a downward bias in a bear or upward bias in a bull. Note that this explosive metal was effectively flatlined for 12 years starting in the early 1990s! Talk about patience.

Second, in real terms today's silver levels aren't high at all. Silver has to head above $19 to exceed its early-1987 parabola. It has to go above $32 to best its early-1983 high. And even at $32, a double from today's levels, silver will still be fairly conservatively priced relative to its best levels in history. It spent nearly two years above $30 real in the early 1980s and better than four years over $20 real. So $16 today really isn't anything to write home about. The majority of silver's current secular bull is likely still ahead of us, not behind.

Silver's 1979 moonshot, still discussed in awed tones by silver traders three decades later, is both encouraging and discouraging. On the exciting side, silver could very well briefly fly to $130 real or even higher at the mania finale of our current bull! Arguments for higher include far less above-ground silver stockpiles today combined with far more paper money sloshing around the world that could chase silver in a mania. Obviously at $130 silver or higher, our profits would balloon beyond comprehension.

But as this next chart shows as it zooms in to the 1970s silver bull, the legendary parabola was so fleeting that it took extraordinary discipline and luck to both buy in early enough and exit quick enough. I hope for and expect another silver super spike at the end of this bull due to silver's tiny market and unique dynamics, but I know full well it is going to be extremely difficult to catch the exact top on the sell side.

Prior to its legendary parabola, silver was essentially flatlined for four years. Four years is a long time to languish in a flat market and tremendously damaging to silver traders' psychology. Most investors who bought in due to the excitement the early-1974 parabola generated had probably long since given up by early 1979. For most of this consolidation, silver merely limped along at less than 2/3rds of its 1974 high.

Then in 1979, this metal's fortunes suddenly changed. Early that year silver started rallying, gradually heading back up to its real 1974 high. Then in late 1979, silver exploded heavenwards as the great commodities bull of the 1970s started to climax in a popular mania. Investors and speculators started to flood into silver and ultimately drove one of the most extreme parabolic ascents ever witnessed in the markets.

From its November 1971 low, silver's 1970s bull ultimately ran for just over 98 months before it hit its January 1980 high. Its price multiplied 37.3x in nominal terms and 19.6x in real inflation-adjusted terms. In today's dollars, silver soared from $6.61 to $129.59! Realize that the oft-repeated simple measure of silver's 1970s performance (3600% gains) is very overstated since it doesn't consider the massive inflation during that decade.

Nevertheless, 19.6x real gains are still stupendously high. But they sure weren't linear like many bulls, making silver's gains extremely tricky to capture. For the first 93 of 98 months of this bull, silver only rose 3.8x from $6.61 to $24.88 real. Then in the final 5 months, starting in August 1979, silver skyrocketed to $129.59 real. Thus 80% of silver's entire bull-market gains occurred in just the last 5% of its bull! Even crazier, fully 50% of its entire bull's gains occurred in the final month leading up to its January 1980 top!

So starting in mid-August 1979, real silver was running just under $25. By early October it had doubled to $50 real. Without the benefit of historical hindsight, would you have wanted to sell after a 100% gain in seven weeks? By late December it had tripled since mid-August to $75 real. On the first trading day of 1980 silver soared 33% to $100 real. Two weeks later it had quintupled since August to $125 real. The gains were so fast they defied belief. Trying to make a selling decision in real time would have been ridiculously difficult.

Leading up to its January 1980 mania top, silver spent just 4 trading days above $120 real. The day after its top, silver plunged 25%. It then spent 19 trading days above $90 real which merely looked like a healthy correction at the time. But then silver started to plummet as these charts show. By March 1980, just two months after the incredible silver apex, the metal was already back down near its August 1979 levels. Silver's entire legendary parabola had soared then crashed back to its starting point within just seven months!

Unfortunately it is not widely remembered today, but silver lagged gold's bull in the late 1970s quite dramatically until late 1979. 4/5ths of silver's entire fondly-reminisced bull market of the 1970s happened in just 5 months at its very end. So realize that due to silver's parabolic nature there is a very good chance that our current bull too will witness most of its gains in its final mania. This is probably several years to a decade away yet, based on historical precedent, so silver traders will have to be patient.

Finally I'd like to zoom in on the early 1970s part of that silver bull. Silver's legendary 1979 parabola was so extreme and chart-stretching that the excellent silver bull from 1972 to early 1974 is often overlooked. But this particular bull phase is probably the most similar to ours today since both are early in secular bulls. Silver started higher in a normal bull-market uptrend in late 1971 but suddenly broke out vertically in late 1973.

I find this chart particularly intriguing today because of this vertical breakout level. Once silver exceeded $15 in today's dollars, it rocketed vertically in its first really big parabola of its bull. It doubled to $30 real in a matter of months. Could the recent similar new silver high of $16 in January 2008 portend a similar quick doubling in the coming months? I don't know, as this is far too little to build a case on. But you have to admit it is an intriguing parallel and possibility.

At Zeal we are very bullish on silver today. The new all-time nominal gold highs are really working to get investors worldwide interested in the precious metals again. As gold is bid higher and excitement builds, as usual late in major gold uplegs the excitement will spill over into silver. Silver speculators will flood into silver futures and probably drive the third silver parabola of this bull. These fast silver gains will generate great interest in silver stocks which should rocket higher even faster than the metal they mine.

In anticipation of another probable silver parabola, we have been aggressively adding elite silver stocks in both our monthly and weekly newsletters. If another silver parabola indeed blossoms late in this gold upleg as expected, we should achieve some outstanding realized gains. Today silver stocks remain quite cheap compared to the prices they'd hit in a parabola, so it isn't too late to mirror our silver-stock trades.

So please subscribe today if you want to see the real-world application of our cutting-edge silver and other commodities research to profitable commodities-stock trading. Our subscribers also get exclusive access to our private charts on our website, which include high-resolution inflation-adjusted silver and gold charts updated monthly.

The bottom line is despite silver's early-2008 surge, this metal still remains quite low in inflation-adjusted terms relative to its modern history. And this is not just in comparison to silver's fabled super spike in late 1979. In today's CPI-inflated 2007 dollars, silver spent about a decade straddling the 1970s and early 1980s well above its current $16ish levels. Silver could easily double from here yet still be very reasonably priced historically.

And silver is particularly exciting today because gold has just broken out to new highs of its own. $900 gold is starting to get global investors really excited about the precious metals again. And when their capital starts to chase silver in earnest, its tiny market assures its gains will be fast and furious like usual. What an exciting time to be long silver and silver stocks!

Adam Hamilton, CPA
Zeal LLC.com

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If you have questions I would be more than happy to address them through my private consulting business. Please visit www.zealllc.com/financial.htm for more information.

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Mr. Hamilton, a private investor and contrarian analyst, publishes Zeal Intelligence, an in-depth monthly strategic and tactical analysis of markets, geopolitics, economics, finance, and investing delivered from an explicitly pro-free market and laissez faire perspective. Please visit www.ZealLLC.com for more information, www.zealllc.com/samples.htm for a free sample, and www.zealllc.com/subscribe.htm to subscribe.

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