-- Posted 12 January, 2011 | | Discuss This Article - Comments:

“Tactical performance” is a word we'll all have to grow accustomed to reading, as more and more weight of the markets is placed in the hands of investment managers or quick acting computer models. 

The best example of tactical performance was the first week of trading for the gold and silver markets, when there were numerous “tactical” changes to investment portfolios, as we just witnessed.  Such reallocation (taking profits from winners, adding to undervalued losers) is big business, and fund managers like to make such portfolio revisions at a time most convenient: late December and early January.

Tax Time

One big reason for this timing is the importance of tax time.  The process of selling winners and harvesting temporary losses is conducted with great precision, as sheltering profits and taking maximum advantage of losers result in a small tax bill.  Precious metals investors, especially physical investors, know this all too well, as taxes are disgustingly high for those who want real assets that can be held in the hand.

It shouldn't be much of a surprise that silver was, for many people, an asset in which they had accumulated very large gains.  Besides palladium, it was the best performing commodity of 2010, but unlike palladium, silver attracted wider investment interest and many more investors as a whole.  

Of course, some of these investors were speculators, hedge funds, or portfolio managers, who understandably, cannot over expose themselves or their clients to an extreme allocation of one asset.  Thanks to SEC regulations, funds must maintain the utmost diversification or suffer penalties.

To meet these guidelines imposed by either themselves or regulatory agencies, silver markets endured a necessary sell off.  This sell off creates what is known as “tactical performance” and is the price performance of a certain asset that happens as a result of tactical shifts in investment. 

Do you think silver lost nearly two dollars in a week because people thought it was worth two dollars less?  No, of course not.  The drop happened because many were forced to, by law or by taxation, to sell their silver holdings.

Splits in the Market

There are, now more than ever, many different splits in the commodities market.  Taking each market at face value, and accepting that their assets are as defined, we would have to accept that there is a futures market, a spot market, an exchange-traded fund market (with many exchange-traded funds), and a physical metals market. 

These markets, unlike the markets for stocks, do not allow for the flow of information to affect price equally.  Let's assume I have one share of stock in, say, Wal-Mart.  I cannot, as I could with silver, buy or sell that Walmart share in a futures market (options are different, they are the option to buy, not a commitment to buy), an exchange-traded fund, nor a physical market.

Such a lack of market crevices means I am quoted only one price, from one market, just as anyone else is.  Demand for Wal-Mart stock always flows through the stock exchange, and so too does supply. 

Silver, however, flows through any number of different markets, which may or may not have an immediate effect on the greater markets.  If I were to sell 5000oz of silver to a silver dealer, that sale would not be recorded at the official futures market unless the dealer then made a sale on the futures market, as well.

Information from the futures, spot, and exchange-traded funds seem to trickle down, but information from the physical market (where silver is actually traded for dollars) never trickles up, or at least not quickly.  Therefore, when prices decline so suddenly in January as a result of “tactical performance” or “tactical reallocation,” just know that it was the temporary supply and demand changes on the central market that moved the markets. 

Imagine if that silver sold in reallocation were absorbed in the physical markets at the various silver dealers.  It would be likely that the resulting wakes of the sales would not reach market until everyone had already forgotten about the tactical reallocation, and based on the generally rising premiums, it appears that many would have been happy to take the silver off the dealers’ hands.

In the places where silver is still being traded for dollars—the local coin shop—there are still plenty of buyers, and there aren't many who are assessing their own “tactical allocations.” 

Dr. Jeffrey Lewis

www.silver-coin-investor.com