On Wednesday I posted on RIM – Research in Motion – Why I Bought It. I won’t re-hash it here; you can read it for yourself. Then on Thursday I posted that Dines Sells Pinetree – That’s Amazing! Again, I won’t repeat myself here; if you are interested in The Dines Letter or PNP.TO – Pinetree Capital Ltd. you can follow the link and read it for yourself.

Also this week I posted a new page called Silver – Why It’s Better Than Gold. (It isn’t really “better”, but it is different, so take a minute to scan the article. I’ll wait).

Now that you are back, here’s my main point today:

Diversification is often over-rated, and at times diversification is stupid.

Allow me to explain.

I am of the view that silver (and gold) are in a long term bull market, for many of the reasons I referenced in the above noted ed Silver – Why It’s Better Than Gold article. If that’s true, it’s likely that the price of silver will continue to increase for many more months, and perhaps years, to come. Yes, it’s highly volatile, but I think we all believe that in the short, medium and long term, then trend for precious metals is up.

If that’s the case, would it not be logical to over-weight your portfolio in silver? Why bother buying other stuff if you believe that silver will go up by more than anything else?

A financial planner will tell you that diversification is important, because if one sector does poorly, and another one does well, at least you reap the gains from the one that did well. If you put all of your money in the weak sector, you can lose big. They would tell you to invest in “opposite” industries, so you are protected from volatility. By “opposite” I mean counter-cyclical, so you invest, for example, in luxury consumer goods (that do well when times are good), and consumer staples that perhaps do better during a recession.

That makes sense, but diversification also means you will only, at best, get average returns. Your winners will be counter-balanced by losers, so you will never hit a home run.

So, in honor of the start of the baseball season, I will offer an alternate view point: just hit home runs.

If you are confident that silver (or anything else) will do well over the next few months or years, then put most of your money in it. If you are totally completely wrong you will lose big, but if you are right, or close to right, you will win big.

In the last twelve months SLW.TO – Silver Wheaton Corp. is up 153%. Obviously the correct choice a year ago was to put all of your money in Silver Wheaton. Most other investments didn’t do nearly as well. (The S&P 500 was up 13%, which is still pretty good).

Am I suggesting picking one stock and putting everything in that one stock? No, because picking the one perfect stock would be close to impossible. If the president of Silver Wheaton resigns and that hurts the stock, I’m in big trouble, even though I was correct about the trend for silver.

What I am proposing is to diversify within the sector, while still loading up on the sector I want to own. So, to that end, this week I began buying, or increased my positions, in the following silver related companies:

In the blue chip, low volatility category:

PHS.U.TO – Sprott Physical Silver Trust As the name implies, this is a trust started by gold and silver guru Eric Sprott that holds a bunch of silver bars representing 22,298,540 ounces of silver, worth around $840 million. All bars are stored at the Royal Canadian Mint in Ottawa, Canada, and you go on the Sprott Physical Silver Trust website and see a list of all bars. That’s good, because most other ETFs loan out their gold and silver, so you don’t know what is actually there. With this one, it’s there, so you know what you are buying. Approximate portfolio allocation – 20%

CEF.A.TO – Central Fund of Canada Ltd. – This fund holds, by dollar value, approximately 45% silver and 55% gold, so it has great exposure to both metals. The Central Fund website has more information, including net asset values. At the moment the premium is only 5.4% over NAV, which is very low, so it’s a good time to buy. Approximate portfolio allocation – 15%

In the blue chip, higher volatility category (with hopefully the potential for greater gains):

SLW.TO – Silver Wheaton Corp. is the mother of all silver stocks. They have royalty streams from multiple sources, so it’s already a diversification play. It’s my biggest blue chipper winner of the last year, and I have no plans to sell. Approximate portfolio allocation – 10%

SSO.TO – Silver Standard Resources, Inc. – I have stink bids in, but no purchases this week. Approximate portfolio allocation – I haven’t decided yet, but probably no more than 5%.

Of course you want some higher risk, higher reward juniors; here they are:

SVM.TO – Silvercorp Metals Inc. – A junior producer, with lots of upside (and potential volatility, so again, stink bids are the way to play it). I’ve owned it for a while, and I’m up over 100% on it, so I have no further purchases planned, but I am holding. Approximate portfolio allocation – 3% (But it’s currently around 8% of my portfolio due to recent gains, so I’m still debating about whether or not to lighten up).

SMD.V – Strategic Metals Ltd. – I did well of this stock in the past, and I’ve got stink bids in on it now; I’d like to start buying around the $2.80 level. Approximate portfolio allocation – 2%

FR.TO – First Majestic Silver Corp. junior with potential;
Approximate portfolio allocation – 2%

FVI.V – Fortuna Silver Mines Inc. junior with potential. Approximate portfolio allocation – 1%

I’ve got a few others on the list, but you get the idea.

As you can see my plan is the heavily weight the less volatile blue chips, and then place my bets on smaller ones for increased potential return.

That’s the plan; we’ll see if I’m correct, or if I get to play the part of the April Fool.

End of the First Quarter of 2011

Now that the first quarter of 2011 is history, how did we all do in our 2011 Predictions, which you will recall, I invited you to submit at the end of 2010? The winner of the first quarter “guess the price of Gold” award goes to Peter518, who was closest with his prediction of $1,450. The actual closing price of gold on March 31, 2011 was $1,431.90, so that’s a quite close.

For the record, I predicted $1,500, so I was somewhat optimistic (as I usually am). The average for the group was $1,463, so the group was also optimistic, but not that far off.

In the “guess the closing price of the DOW” category, the winner was JohnB, with a prediction of 12,500. The actual closing price of the Dow was 12,319.73, so that’s also very close. Honorable Mention goes to both Peter518 and yours truly, JDH, with our prediction of 12,000. The group average prediction was 12,333, so as is often the case the group was once again eerily accurate.

That’s my report for the week. Thanks for reading; feel free to post your thoughts on the Buy High Sell Higher Forum, and see you next week.

It seems Bart has found the right formula for making money, as many a Springfield kid is in the Simpsons basement, shelling out big bucks for the spectacular Super-Barto Jackpot Drawing.  Tennis balls, baseballs, and the occasional apple are all stuffed into the dryer machine, today’s boy’s cheap alternative to a drawing machine. But all dryers have their limits, and this one starts rattling wildly out of control.  Bart leans over the dryer to reach the “Off” button, but doesn’t succeed.  The dryer is pulling the gas conduct as far as itcan go, and it quickly snaps, turning the gas dryer into a flame-thrower. The kids scale the stairs in terror.

“No refunds, force majeure, read the back of your tickets.”– Bart Simpson

The world keeps getting scarier and scarier. Last week I wrote, extensively, about why gold is falling, and why gold will spike up in November. So far, my prediction is looking completely wrong. Of course, I’m looking wrong only if you believe things will get better, soon.

It looks to me that the world is getting far worse, not far better.

Thanks to yellowcaked (a.k.a. “The Chairman of the Board”) over on the Forum for this link to a story on Gold Price Manipulation by Rob Kirby. I suggest you all take five minutes to read the article.

I’ll wait.

Now that you are back, if I may summarize what you just read, it goes something like this: Bear Sterns was “long” on gold. They were holding around $12 billion worth of long gold futures, betting that the price would go up. On the other side of the table was JP Morgan Chase, who were betting on a decline in gold, and therefore had billions of dollars of short derivative contracts.

On the weekend of March 15, 2008, with gold trading above $1,000 per ounce, the take out of Bear Sterns was arranged, and JP Morgan got to see their books, where they discovered the huge Bear Sterns long position. So what does JP Morgan do? They “fire bomb” the price of gold, (by either buying more shorts, or selling long contracts) driving the price of gold down by $100 from March 17 to 19. As a result of this drop, the book value of Bear Sterns’ long position drops by millions of dollars (probably over a billion, actually), putting them in an even weaker position for the take over that finally happened on April 8, 2008. Of course it also made JP Morgan’s short positions even more valuable.

(Last week I included a link to the Office of the Comptroller of the Currency and the June 2008 report (here’s the pdf link; look on page 29, in Table 9 where we could easily see that, yes, in fact, JP Morgan controls a huge amount of derivatives in gold).

So, why is it that physical demand for gold is going through the roof, but the paper price has been dropping since March? Could it be the billions of dollars of manipulation introduced by JP Morgan?

Could be.

There are two schools of thought on what the future holds, summarized as follows:

1 Everything will be fine. The USA is the economic engine of the world. Americans invent more products, and consume more products, than anyone else. The USA is also the police force of the world, so long term the USA will be in great shape. The events of the past few months are just a temporary set back. This market bottom is a great buying opportunity, so start buying.

2 The world is ending. Well, not actually ending, but the financial world that we knew and loved is being drastically altered. Some exhibits in support of this theory:

First, thanks to yellowcaked for this link to an article from the Jim Willie newsletter. I’ll let you read the entire article; the grammar and writing style is not great, but I agree with his main point: paper currencies are dying, eventually to be replaced by a currency backed by gold.

Second, thanks to whatsupdoc for the link to the Brokers With the Hands on Their Faces Blog. You know things are bad when every newspaper and on-line news source has to run a picture like this every day.

Third: Okay, enough goofing around, the real argument that proves that we are in bad shape is the disjoint between the price of physical gold and the price of “paper” gold traded on the Comex. We discussed gold lease rates and physical gold last week, so I won’t elaborate again. However, let’s cut to the chase:

The price of gold and silver has been falling since March, and yet if you actually go and try to buy physical gold and silver, supplies are very short. I’ve tried, in numerous different places. There is some supply available, but not much. Back on October 4 I reported that there was virtually no silver available at Scotiabank in Toronto; I wanted to buy 100 silver one ounce Maple Leaf coins, and they would only sell me 25 of them, for a total purchase of only a few hundred dollars.

In other words, the laws of supply and demand don’t seem to apply; even with no supply, the price is going down.

Of course we know that is not the case. The price of the physical metal is going up. On eBay or in any coin shop you will pay a significant premium over the spot price. Now here is the kicker:

If I can go and buy a contract for the delivery of 1,000 ounces of silver on the COMEX for $9.40 per ounce, and take delivery and sell that 1,000 ounce bar at my local bullion dealer for say $11 or $12 or $15 per ounce, why wouldn’t I do that?

I would. It’s called arbitrage, where you can buy something in one market and sell it in another.

In the past, it has never made sense to take physical delivery of a 1,000 ounce bar of silver, or a 400 ounce bar of gold. You would need to arrange transportation, insurance, storage in a secure vault, and then perhaps pay assay charges when you went to sell the metal. It’s much easier to simply sell a paper representing the underlying asset. No storage. No insurance. No delivery costs. Simple. And that’s exactly what’s been happening. Traders have sold the paper.

But what happens when someone, who understands arbitrage, decides to actually take delivery of the metal?

And what happens when there is no metal to deliver?

You see, my friends, the only way JP Morgan and the other big boys could have crashed the market, is by selling short product that they don’t actually have. As long as no-one asks for the product, the game is on. But as soon as someone asks for delivery, the gig is up.

John Embry of Sprott Asset Management stated on BNN (the Canadian Business News Network) on October 21, 2008 that he believes many investors will take advantage of the arbitrage opportunity, and start taking delivery, probably with the December contracts. If a significant number of contract holders elect to settle in physical metal, there will not be enough metal in the vaults to meet demand. (You can watch the clip on BNN; start watching at around the 13:50 mark).

He believes the exchange will have to declare force majeure to prevent disaster. In other words, the market will say “sorry, we don’t really have your gold and silver; due to exceptional circumstances, we will allow the contracts to settle in cash, not metal.”

And guess what an admission that there is no metal will do to the real price of gold and silver? It will make it go through the roof. Which is why I continue to believe that November or December will be a great month for gold or silver.

Bart Simpson had to declare Force Majeure when his little scam blew up, with disastrous consequences; the explosion of the COMEX will be similarly deadly.

So I will repeat my plan: I will continue to buy whatever limited amount of physical gold and silver I can (and store it in a bank safety deposit box or other secure facility; I have no intention of keeping it at home). As an aside, Sprott Money is selling physical metal; this may be a great solution for Canadian buyers.

I will not sell any of my gold stocks. I’m not buying more now, but if we keep having down weeks the temptation will grow to average down. I have sold November calls against the gold stocks I own, so that if prices do drop further I will at least pocket the premium.

I will keep holding my RSW – Rydex Inverse 2X S&P ETF, which so far have been great insurance against the crashing stock market.

The rest of my money will be kept in cash.

It’s a simple plan, that will either work out brilliantly, or be totally wrong if the governments of the world keep propping up the markets. Time will tell, but I believe time will tell soon.

As always, thanks for reading, and feel free to respond below or on the Forum.

See you next week.