Saturday , 23 August 2014

If You Think Silver Is Going To Increase In 2013 Here's How to Best Maximize Your Return

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The article gows on to say, in part:

I like silver because:

  1. 65% of silver use in for industrial purposes and photography, and only 20% or less is for investment….[which] makes silver more like a real commodity than a hyped precious metal that has no intrinsic value or practical use and trades purely on sentiment, like gold for example. When industrial growth is back, so is silver. With the worldwide expansion in monetary policy to engineer industrial growth, I believe silver demand will explode in 2013, and with it prices will go up.
  2. The Central Banks around the world are engaging in a coordinated reflation and consequent accommodative monetary policy and, to put it bluntly, they are printing cash like it is going out of style. While I wish them best of luck in their effort to create some inflation and get the world economy out of the deflationary spiral it is in, I am not convinced they will be able to do it easily, and far more cash infusion will be needed than currently planned….[As such,] people will be expecting inflation, and this should give a boost to silver prices as well.

So, how to make money out of this trend?

  1. invest in silver ETFs. The bread-and-butter ETF for silver investors is the iShares Silver Trust ETF (SLV). It tries to reflect the price of silver. The biggest and the most liquid of all silver ETFs, this is something any silver investor should consider. The ETF has been up about 4% this year, but over the long run it has doubled over the past 5 years as the price of silver has skyrocketed.
  2. invest in leveraged ETFs on the future price of silver….

I am a big fan of leveraged ETFs…[as they] open up all kinds of possibilities because of the unique way they are constructed.

1. First comes the 2x leveraged ETF pair, the ProShares Ultra Silver ETF (AGQ) and the ProShares Ultrashort Silver ETF (ZSL). Both of these try to replicate on a daily basis 2x or -2x the performance of the SLV ETF. As the chart shows, AGQ is down about 5% for the year, while ZSL is down about 33%.

Curious, isn’t it? While the base ETF is up slightly, the 2x leveraged bull ETF is down instead of up, and the 2x bear ETF is not only down, it is down by much higher than the 10-15% that one would have expected it to drop. This is what makes leveraged bull and bear ETFs such fascinating creatures. they erode value over time with volatility and hence open up several interesting opportunities….

2. What about their 3x leveraged ETF cousins, the VelocityShares 3x Silver ETN (USLV) and the VelocityShares 3x Inverse Silver ETN (DSLV)? Turns out they are down 19% and 49% respectively in 2013, keeping up with the high value erosion expectations bestowed on them.

How should a silver investor profit from this trend in 2013?

Let’s first examine how much value these 3x leveraged ETFs have eroded since inception. The charts below shows that.

USLV Chart

It seems that in only about a year, the 3x leveraged ETFs have managed to wipe out ~50% of value. For someone who shorted them, that’s doubling of the money in a year. Unfortunately, it is very hard to short these leveraged ETFs…[and no put options exist on them].

What about the 2x leveraged ETFs? As the below chart shows, these look very promising.

AGQ Chart

Since inception, AGQ has given somewhat higher returns than SLV so, while it has eroded value, it has not eroded a whole lot of value. Investors, however, have hit pay dirt when it comes to ZSL. It is down 99% over 4 years. If an investor could have shorted this since inception, he or she would be up 100x, enough to retire a few times. Trouble is, ZSL is not very shortable either. Good news, however, is that put options exist on it.

The January 14 expiration 50 strike puts on ZSL are trading at $10.60/14.20 (bid/ask) so what is the expected profit of buying these puts?…

  • I assumed that SLV grows by 15% in 2013 and its daily volatility remains unchanged. With that, I created a set of 240 daily returns for SLV, and 240 daily returns for ZSL leveraged at -2x for SLV. At the end of the 240 daily returns, I estimated the price of ZSL and that of the January 2014 strike 50 put on ZSL. I assumed that the cost to buy the put is midway between bid/ask, or $12.40. Over the 5000 Trials, the 95% confidence interval for the expected return of buying this put is 80-87%. In other words, there is a 95% probability that this put returns 80%+ in 2013, if SLV were to return 15%.
  • If SLV returns 10% in 2013, the expected return of the put with 95% probability is 46-52%.
  • If SLV returns 5%, the same as in 2012, the expected return of the put with 95% probability is 26-33%.

Conclusion

I expect SLV to return at least 15% in 2013 based on the rationale above, so I think it is safe to assume that doubling of value with this put is not unreasonable. Of course, you are risking 100% downside as well, as the put may expire worthless but the simulation shows that the odds of that are miniscule, assuming silver does at least as well in 2013 as it did in 2012.

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*http://seekingalpha.com/article/1081861-a-high-risk-high-reward-play-for-silver-in-2013

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