Sunday, August 14, 2011

Q&A With The Doc: Will Mining Stocks Outperform Physical in the End?

John writes:

Thanks for your hard work getting silver to the masses and educating us on the finer points.
I've heard from a number of sources that when d-day comes, gold/silver shares will outperform the physical metal. I guess that it is because in the heat of the moment the masses wont be able to buy physical because there are no supplies, so in order to get expose to gold/silver they will rush to buy stock - as they can always be bought for a price. Can you clarify this point please.
Thanks again Doc!

John, excellent question, and one that applies to nearly every silver investor.

Silver mining stocks provide an excellent leverage opportunity to the future gains in the price of silver, but they also come with many risks that are not associated with physical gold or silver.

In the long term (or come D-Day as you describe it) we believe the risks to silver stocks include:

1. Nationalization.  We believe risk of government confiscation of physical gold and silver to be negligible.
Why? Unlike in the 1930's, less than 1% of Americans own any gold or silver bullion.  As a general population, the people have nothing to confiscate!
If the government ever does decide to confiscate gold or silver, we believe it will be by nationalizing gold and silver mines. 
One simple executive order or presidential decree, and SLW, AUY, AEM, ANV, etc can suddenly be declared US national assets, making your mining stock essentially worthless.

2. Counterparty risk. Unknown to most investors, common stock holds counter-party risk to the actual holder of the stock, the DTCC.  Common stock certificates in the US are actually owned by the Depository Trust and Clearing Corporation (DTCC).  The DTCC actually owns your stock certificates. (Unless you hold the paper stock certificate in your hand, as Jim Sinclair has advocated for years) 
For those who missed it, the S&P DOWNGRADED the DTCC this week to AA+.
Essentially S&P is stating that the company that physically owns your stock certificates is no longer worthy of an AAA credit rating. 

3. Hyperinflation. We believe that the end game of the worldwide fiscal/debt crisis will be a hyperinflationary episode or a currency devaluation.
Unless you hold physical stock certificates, mining stock (and all stock) will be essentially worthless during hyperinflation as you will not be able to sell the stock without experiencing a major hit from hyperinflation.
Why will the stock be essentially worthless during a hyperinflation?

What occurs when you sell stock today in your online brokerage account?
Say for example that you have 500 shares of SLW you would like to sell. 
When you sell your shares, do you have instant access to the cash?  No, the funds are not available to you typically for 3 business days while the payment is processed and cleared by your brokerage company. 
After 3 days, the funds are freed in your account, and you can write a check, withdraw the funds to your banking account, etc, which will take another 1-2 days to clear into your account.
In all, this is 4-5 days at a minimum before your stock becomes cash in your hand.
DURING hyperinflation, your cash is being devalued HOURLY. 
One single day parked in cash can easily devalue your wealth by over half during hyperinflation.
We believe that during a period of hyperinflation, stock held in an online brokerage account will essentially be illiquid for this reason. 

4. Manipulation. Unlike physical silver, the cartel's manipulation of gold and silver mining shares is potentially limitless, only limited by available cash, of  which the banking cable has no short supply. 

In the short to medium term, good gold and silver mining stocks (ANV, Silver Wheaton, and First Majestic are our favorites) provide leverage to silver's gains, and also provide an easy way to trade in and out of silver to maximize gains.  For example, we sold our AG stock on 4/6 at $26.85 after watching AG run nearly 10 fold from $3.50 to the upper $20's.  AG topped literally seconds after our trade only 3 ticks higher at $26.88 before selling off to ~$16. (we don't nail every trade like this, but this is an example of how one can profit from silver's volatility in the short term)
However, most silver investors in the general public are not emotionally able to effectively trade in and out of stock to maximize fiat gain, so we typically do not recommend this strategy to readers.
Also, our mining shares were established using funds we can afford to lose entirely, and only AFTER establishing a SIGNIFICANT physical position.  (Our mining shares account for roughly 4% of our entire it play money if you will, as we attempt to leverage silver's volatility and gains with the hopes of turning them into physical before it is too late)

As to your inference that the general public will flock to the miners as a result of a lack of supply of physical, we agree to some extent.
Physical gold and silver will always be available- at what price is the question.
The day is quickly coming that gold and silver will not be available at the official paper COMEX price, but they will always be available at their real, much higher, true market price.
The real reason that the public will flock into the mining shares is that they are used to investing in paper.
Nearly everyone has a 401 or a stock brokerage account, and mining shares will be the most natural and easiest way for Joe Sheep to enter the precious metals market.

I hope I have satisfactorily answered your questions John, as well as sufficiently explained why we believe physical silver (and gold) are the best choices to preserve your wealth THROUGH a hyperinflationary/ currency devaluation episode.