Is Silver Just Another Speculative Bubble?

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Gold recently struck six-month lows as key players like billionaire George Soros and others cut their holdings of the yellow metal. Silver was quick to follow in the sell off. Both the SPDR Gold Trust (NYSEMKT: GLD) and the iShares Silver Trust (NYSEMKT: SLV) recently traded lower for five consecutive days.

Investors are now left to wonder if the recent selling pressure is just a sign to come. If a slight change in investment demand from a few fund managers can send gold and silver sliding, what would a reversal in investor sentiment mean for gold and silver?

A bubblicious boom

It would not be fair to discuss only gold and silver's most recent (very poor) performance. Gold is up some 69% over the past five years while silver is up 62% in the same period despite a recent sell off. Both returns are impressive given that neither gold nor silver have fundamentally changed in the last five years. Gold and silver are, as they have been, mere metals among men.

But what has changed in silver is the amount of speculative investment demand. I suggest that silver investors don't merely participate in the market for silver, silver investors are the market for silver.

In 2006, when silver was $11.54 an ounce, implied net investment in silver plus silver used in the making of coins and medals was 94.9 million ounces. Compare that to 2011, when silver bugs showed their loyalty to the second-favorite precious metal, purchasing 282.2 million ounces of silver coins, medals, and investment products, according to data from the Silver Institute.

Silver investors' tremendous impact

Silver investors acquired 27.1% of all silver demanded in 2011, compared to only 10.2% in 2006. In just five short years not only did investment demand grow by nearly 170%, but it also grew so quickly that investors were able to displace the rapid decline in photographic, jewelry, and silverware demand.

Repeat: silver investors have been the primary driver of silver demand, making up so much of the pie that they now displace a decline in photographic, jewelry, and silverware demand over the past five years. Silver investors are the market for silver demand.

In short, investors, not end-users, make up far more of the silver market today. And over the past few years, silver investors have accumulated hundreds of millions of ounces – more than one half year of all production in the finest of purities – which could be quickly and easily dumped upon the market at any given time.

Silver is the ultimate in speculative bubbles. It produces no value, no cash flow, and a single ounce of silver will never turn into two. It is as unproductive as an asset as one can own. Once the masses come to realize that their profits are contingent on new and more silver investment, silver's meteoric rise will come to an end.

How to place strategic silver bets

Exposing yourself to crumbling silver prices is as easy as sticking to the firms most levered to silver prices.

Here are two great ways to play silver's fall:

Silver Wheaton (NYSE: SLW) - A silver streaming company, Silver Wheaton provides financing to small miners in exchange for a share in metal production over the life of the mine. The company, like many involved in the silver business, has spent virtually all of its free cash flows on continued reinvestment into new mining contracts. The business is essentially built on ever-rising silver prices, as with each new mine it finances, the company exposes itself to more higher-cost operations. Any drop in silver prices is magnified by the company's operating leverage.

Global X Silver Miners ETF (NYSEMKT: SIL) - This fund tracks 33 different silver miners that are engaged in the exploration and production of silver. Top holdings include well-known industry players like Hecla Mining (NYSE: HL)Pan American Silver (NASDAQ: PAAS), and the aforementioned Silver Wheaton. All three companies have spent significantly on capex in the last two years to further develop income streams based on dangerous assumptions of today's exceptionally high silver prices. A broad play on the silver mining industry, this ETF focuses investors on the capital intensive business of pure mining, making it more strongly correlated to a long-term decline in spot silver prices.

Foolish investors who time the mean reversion correctly stand to profit handsomely when silver goes from being "in" to undeniably "out" with investors.

valuemagnet has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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