Practical advice Friday: What form of Silver should you hold?

October 12, 2012
Frankfurt, Germany

Along with gold, silver has been considered money for thousands of years. In ancient Rome, for example, the silver Denarius coin was first minted in the third century BC. It contained about 4.5 grams of silver and would have a metal value worth roughly $5 in today’s money.

We talk a lot in this column about the importance of owning precious metals… and often for the sake of convenience, I lump gold and silver together in the same category. But while the two share similar characteristics as excellent inflation hedges and stores of value, silver has unique fundamentals worth considering.

For starters, while the entire gold market is small, the silver market is even smaller. It’s tiny. As such, silver is highly volatile and even more susceptible to wild price swings than gold.

This means that, in a boom, silver is going to rise more rapidly than gold. In a bust, silver is going to drop more rapidly. We saw this a few year ago after the Lehman collapse, silver dropped to $8, then subsequently reached a peak of $40. Gold’s roller coaster ride was nowhere near as severe.

This gives silver an interesting edge as a speculation. And one way to play this is to buy specific types of silver whose premiums soar during financial panics.

Last week, you heard from my friend Jake Lawless; he’s something of an expert when it comes to gaming the system, and I asked him to weigh in on this topic of ‘silver premium arbitrage.’ From Jake:

It’s true that not all silver is created equal. Every type of refined silver is going to sell for the spot price (melt value) plus an additional markup. This markup is called the premium… and premiums vary dramatically from one form of silver to another.

As I wrote last week, my preferred form of physical silver is pre-1965 US dimes, quarters, and half dollars… known in the industry as “junk”. Junk silver as an investment. It has a nice ring to it.

In a financial panic, people who procrastinated about buying real money (precious metals) all try to rectify the situation with predictable results. Suddenly, they want gold and silver, and junk silver is quite popular.

First, it’s easy to buy. Everyone in the US knows what a dime or quarter looks like, and all you really have to do is make sure that the date is before 1965.

It’s also easy to buy in small amounts. At $30 an ounce, a silver quarter costs $5.36 and a dime $2.13. More people can afford that than the hernia-causing 1,000 ounce bar at $30,000+. This affordability factor is a huge reason why demand surges for junk silver during panics.

When demand surges, the premiums go up. During the last panic in 2008, premiums on junk went from 29 cents to $4 almost overnight.

At the time, I went to my coin dealer and sold some physical silver for cash. The spot price was $25, so I received $25 + the $4 premium, or $29 per ounce.

Then I called my commodities broker and bought a 1000 ounce futures contract priced at spot, or $25. In this way, I pocketed the $4 premium, but I still had exposure to silver.

As expected, the world didn’t come to an end, and the panic subsided. Silver premiums returned to normal, and I soon took delivery of an ugly 1000 ounce bar. My coin dealer then swapped me for 1000 ounces of junk silver again.

So essentially, I swapped junk silver for cash, cash for a futures contract, the futures contract for a 1,000 ounce bar, and the bar for junk silver. It didn’t matter if the price of silver went up or down in the meantime… I ended up right back where I started, except that I put the huge premium in my pocket.

That’s the basic strategy, and you can do the same. Again, I use junk silver because I have not seen this kind of premium spike in any other form.

If you can, I recommend having at least $500 face value in these coins stored somewhere safe yet easy to access. At Thursday’s close, my dealer was selling junk at 35 cents over spot (or $34.45) with free shipping. A bag of $500 face contains 357.5 ounces and costs $12,315.88.

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