Silver: This Is Awkward
Timothy Olyphant in Go (1999) explaining why he hates The Family Circus.
Damn. We're Bullish On Silver Again
Well, this is awkward. Let's drop the royal "we" for this post. I, David Pinsen, the founder of Portfolio Armor, called silver "The Family Circus of investments" a few days ago. That was an allusion to this scene in the 1999 movie Go where one character explains why he hates the comic strip The Family Circus.
It's funnier hearing Timothy Olyphant tell it, but if you don't have time to watch the clip above, he hates it because it's the last thing he reads on the comics page, sitting on the bottom right "just waiting to suck". That's how I felt looking at silver names like the iShares Silver Trust ETF (SLV) drag down the performance of Portfolio Armor's top names, as it (and other precious metals names) are doing with our August 13th cohort.
Then I check my site on Thursday night and it's bullish on SLV again. I'm still not a fan of precious metals personally, but Portfolio Armor is better at picking securities than I am. Let's look at why it's bullish on SLV again.
Breaking Down My Site's Analysis Of SLV
Here's the relevant part of SLV's entry on Portfolio Armor's admin panel as of February 11th. I've numbered the columns so I can explain what they mean below.
1) The Long Term Return there is the average 6-month return of SLV over the last ten years. It's -0.75%.
2) The Short Term Return there is the most recent 6-month return, 7.54%.
3) This column shows the mean of 1) and 2). It's now positive, at 3.39%, so SLV passes our total return screen now. If failed this earlier in the week.
4) That mean number becomes the site's preliminary potential return over the next 6 months.
5) The"w/Cap Drop" refers to the first gauge of options market sentiment the site applied to SLV. It attempted to hedge it against a >9% decline with an optimal, or least-expensive, collar over the next ~6 months capped at the figure from the last step, 3.39%.It found an optimal collar with that cap, so it moves on to the next step.
6)This is the big one. The "w/AHC" column refers to the second gauge of options market sentiment it applied to SLV. Essentially, it's a gauge of options skew: it scanned for another optimal collar against a >9% decline over the next ~6 months, but this time it used a cap of 1% or the current money market yield, whichever was higher (it used 1% in this case). You want the net hedging cost here to be as negative as possible. Here's what it looked like for SLV on our app on Thursday.
That net cost, -7.41%, was one of the ten most negative in the system's universe on Thursday.
7) and 8) are other gauges of options market sentiment that don't apply to SLV.
9) "TTE" is time to expiration. This is an adjustment the site makes to potential returns for securities whose hedges expire in less than 6 months. Doesn't apply to SLV.
10) Hedging Cost. The cost of hedging SLV against a >9% decline when capped at the value in 3).
Why Did SLV Get Such A Big Boost?
The mean of SLV's most recent 6-month return and its average 6-month return over the last ten years was a modest 3.39%. Then in step 6) above, its potential return estimate got bumped to ~108%. Why? To be clear, I don't think SLV is going to double in the next six months. I'm not even confident it'll post a double-digit return over that time frame. But let me explain the math here.
We've been tracking the performance of names that pass the screen in step 6) versus ones that don't since August of 2019. The average name that passes that screen has outperformed the ones that didn't pass by about 30.9% over the next 6 months. Actual returns of our top names have averaged 0.295x our potential return estimates so far. So, to translate that 30.9% advantage into potential returns, the site divided 30.9 by 0.295 to get ~104.7%. Adding that to the 3.39% figure got ~108%.
Why Inflate The Potential Return?
Because the site uses it as a guide in where to cap the collars of securities in hedged portfolios (this explains how it decides to hedge with collars or puts). Because some top names end up posting negative returns, the average actual return is 0.295x the average potential return, but the site wants to catch as much upside potential as possible when hedging. So the potential return is a bullish estimate. When you ask the site to create a hedged portfolio, it gives you an expected return at the end which takes into account the hedging cost and the current expected return adjustment (currently 0.295x). Basically, it inflates the potential return to facilitate hedging that catches most of the possible upside, and then it deflates it down to an expected return for the portfolio as a whole.
Here's an example from my previous post to illustrate. This was the hedged portfolio the site created for an investor with $3 million to put to work on December 17th who was unwilling to risk a decline greater than 30% over the next 6 months.
You can see in the summary at the bottom that the aggregate potential return of the portfolio was 85.12%, but the expected return, at the bottom right, was 16.02%.
The preliminary performance of that portfolio, as of Thursday's close, was in the ballpark of that 16.02% expected return at 14.47%.
Back To SLV: A False Positive?
That's my guess. The site's gauges of options market sentiment pick duds occasionally. But, as I said, the site's better at picking winners than I am. So you silver bulls can take that as encouragement. It might not be the Family Circus of investments after all.