The Institutionalized Silver Market
by Sean Rakhimov
- Where were are
If you're still questioning the main premise of this article, we'll briefly remind you that the likes of John Paulson, Paul Tudor Jones, David Einhorn and a host of lesser known money managers have recently joined the party as has been amply discussed by others. The purpose of this missive is to shed some light into what it might mean to you, the "average investor" and if there are angles to be exploited in that regard.
We also have to mention the blockbuster purchase of 200 metric tonnes of gold by India's Central Bank from the IMF. With that deal in the books there should be no doubt in anyone's mind that gold and silver are hitting the mainstream.
- What does it mean?
1) These early and prominent leaders into precious metals will be imitated and followed by their less bold or, if you prefer, more conservative peers. That goes for both fund managers and central banks. In that light, if there ever was a time to follow the trend/money, this would be it. We're in the early stages of acceptance of gold (to be followed by silver) by the establishment as a legitimate investment instrument. These are not yet panic days, but naming gold as an investment choice won't raise eye-brows at cocktail parties going forward. You might still get some show of bewilderment, though not far beyond this coming Christmas season. Better yet, it might buy you a few nods of approval on this stretch. Certainly, you won't be instantly discarded as a screw-loose maverick, as was the case only a couple of years ago.
Further into 2010 and beyond, it is likely to become fashionable and perhaps understood that anyone with any sense of the market "has to have SOME gold"; and if you don't, your fellow fund managers will send you condescending looks as if to say "Don't you know everyone is in on the gold game?".
But everyone won't be, it will take time for a lot of newly converted believers to move into gold space and, more importantly, there isn't enough capacity in the sector to accommodate any significant influx of money. The thing to note here is that many funds that never had any exposure to precious metals or commodities will enter this space for lack of better alternatives, at least with a portion of their portfolios.
2) Expect substantial growth in assets under management of the better established precious metal funds, due to inflow of new funds from various sources, including funds operating in other sectors. Another reason will be the rise in share prices of precious metal fund holdings, which will suddenly make them viable competitors for investment dollars with their peers. For instance, a Vanguard Gold Fund would evolve from an obscure specialty fund with comparatively measly assets under management into, at first, a solid and sizeable fund, and later, a top performer and flagship within the group.
2) Expect substantial growth in assets under management of the better established precious metal funds, due to inflow of new funds from various sources, including funds operating in other sectors. Another reason will be the rise in share prices of precious metal fund holdings, which will suddenly make them viable competitors for investment dollars with their peers. For instance, a Vanguard Gold Fund would evolve from an obscure specialty fund with comparatively measly assets under management into, at first, a solid and sizeable fund, and later, a top performer and flagship within the group.
This should happen across the board and around the globe. Since success breeds success, it should be followed by increased percentage allocation of investment portfolios to the best performing funds. Remember Fidelity's Magellan fund getting so big it had to close doors to new investors? We expect things to play out in that direction. Not right away, but somewhere on the horizon, in the mania stage.
This is where things get interesting, so let us set the stage. In the diagram below we tried to identify the dominant money flow trends and highlighted them in shades of green based on where each group of investors is likely to direct the majority of their investment capital (yes, every player in the space will be at once the recipient and allocator of capital). We intentionally downplayed the impact of retail investors at this time, as their day in the spotlight is yet to come during the final blow-off stage of this bull market.

As you can see, we believe the main beneficiaries from money flow trends will be the mid-tier companies; those with established resources and production. This group should be the main focus of precious metal/resource funds and at the same time, become a takeover target for the majors. The acquisition of Canplats by Goldcorp, is a good example of what we're talking about.
The main criteria that may be helpful in spotting these companies are:
We certainly don’t mean to imply that companies elsewhere in the spectrum will not perform well or should not be considered. On the contrary, rising tide will lift all boats without holes in them. Speaking of holes, this is an industry where one drill hole can change the fortunes of all but the largest companies on any given day. So, by all means, entertain all options. That said, this market has gone institutional and the trend is your friend.
- What is a poor fund manager to do?
- The first thing you do is look at the ETFs and other similar vehicles that provide exposure to the sector without having to deal with the nitty-gritty picking stocks. But the space is crowded;
- Then you look at the indexes and drill down to the blue chips. That's nice, yet you soon discover that valuations are defying gravity;
- Next, you check the top holdings of the best precious metals you can find and move into them;
- Do your due diligence and try to make your own picks, but that is a whole lot of work.
This is where things get interesting, so let us set the stage. In the diagram below we tried to identify the dominant money flow trends and highlighted them in shades of green based on where each group of investors is likely to direct the majority of their investment capital (yes, every player in the space will be at once the recipient and allocator of capital). We intentionally downplayed the impact of retail investors at this time, as their day in the spotlight is yet to come during the final blow-off stage of this bull market.

- How to play it
As you can see, we believe the main beneficiaries from money flow trends will be the mid-tier companies; those with established resources and production. This group should be the main focus of precious metal/resource funds and at the same time, become a takeover target for the majors. The acquisition of Canplats by Goldcorp, is a good example of what we're talking about.
The main criteria that may be helpful in spotting these companies are:
- Established resources in the ground. Some of the hard and fast numbers to help sort companies are 5+ million ounce gold or 100+ million ounce of silver deposits will be picked off first, however all ounces are not created equal and other considerations apply in the selection of potential takeover targets.
- Production profile. Ultimately, production is the goal for majors, so the closer the project is to production, the more attractive it becomes. We would be looking at companies producing 200,000+ oz of gold with 15+ year mine life.
- Market capitalization. Another filter investors can use when looking at these stocks is market capitalization. Mid-tier companies, depending on various factors and development stage, will usually sport market caps of $200-300 Million at the lower end for explorers, to $1-2 Billion at the higher end for producers. Certainly, these are not all-encompassing brackets, but by and large the companies discussed above will fair somewhere in that range.
We certainly don’t mean to imply that companies elsewhere in the spectrum will not perform well or should not be considered. On the contrary, rising tide will lift all boats without holes in them. Speaking of holes, this is an industry where one drill hole can change the fortunes of all but the largest companies on any given day. So, by all means, entertain all options. That said, this market has gone institutional and the trend is your friend.
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