Silver's Soaring -- Time to Protect Your Profits

I’m not going to pretend I’m smart enough to call the top of the market in silver. As John Maynard Keynes once said, “Markets can remain irrational longer than you can remain solvent.”

I have no idea if silver will top out at $50 an ounce, $100 an ounce, or more.

But I do know one thing. I’ve seen this movie (twice) before, and I know how it ends. Which is why I recommend that you take a breath and think about how and why you should protect any profits gained from silver’s recent meteoric rise.

Investors have short-term memories and always say, “This time it’s different.” But it’s not. Sure, our problems, challenges and successes are not the same as the past, but human nature does not change.

The Same Arguments During the Real Estate and Internet Bubbles

I sat front and center for two bubbles in the past decade and heard the same argument both times.

While living in San Francisco during the dot-com bubble, 32-year-old paper millionaires would routinely tell me that they planned to retire in two years. Everyone was trading stocks because “it was the only way to make money.” Books were written claiming the Dow Jones Industrial Average would go to 36,000.

The Internet was a whole new “paradigm shift.” Life would never be the same.

The Internet did in fact change the way we work and live. But after a little while, the markets became sane and stocks were valued appropriately. As a result, investors in many dot-com stocks got crushed and the 32-year-old paper millionaires are now 42-year-old thousandaires who still work for a living.

Fast-forward five years. It’s 2006, and I now live in Florida, one of the top markets for real-estate speculation. At a dinner party, a pharmaceuticals salesman tells me real estate “is the only way to make money.”

On the way home, my wife chews me out for not being like the pharma rep and missing the opportunity to buy property in St. Lucie County, where land is cheap and investors are flipping houses and home sites.

Five years later the housing market still hasn’t recovered from the crash. Certain neighborhoods in Florida, especially in St. Lucie County, still look like a Category 3 hurricane blew through it with half-finished or abandoned houses that have been ransacked.

The Recent Rise in Precious Metals

So when it comes to the recent rise in precious metals, let me be absolutely clear: This time it’s not different.

Yes, I know we have a debt problem in this country. Yes, silver has industrial uses. And as a result, perhaps silver will never return to the lows of even just a few years ago.

But when:

• CNBC is broadcasting from coin-dealer shows;

• the U.S. Mint has sold out of Silver Eagle Coins;

• and blogs are calling for silver prices of $750 an ounce, $2,000 an ounce, or even $4,000 an ounce ...

... we’re getting close to a mania (if we’re not in it already).

Keep in mind, I’m not bearish on the metal. In fact, I believe precious metals belong in most people’s portfolios. I agree with The Oxford Club’s asset-allocation model, which holds that 5% of a portfolio should be invested in precious metals. I’ve even done that myself.

I’m not a mining expert, but what I do know about is investor behavior and the market's history of repeating itself over and over again.

Above is a chart of the Nasdaq Composite Index during the bubble days, compared with silver today. You can see that the pattern is similar. We know what happened next on the Nasdaq chart. Will silver follow?

Protect Your Silver Profits with Puts and Trailing Stops

If you’re an investor in silver, you need to start protecting your profits. I’m not going to tell you to sell your silver. Silver bugs won’t do it anyway. But I’m hoping that there are enough rational people out there to, at the very least, buy some insurance on it -- just in case it corrects or it turns out that it really isn’t different this time.

Whether you own stocks such as Silver Wheaton Corp. (NYSE: SLW), coins, or the iShares Silver Trust (NYSE: SLV) exchange traded fund (ETF), consider buying some puts. If you can’t buy puts on the miners, you can do so on the ETF.

A put is an option (but not a requirement) to sell a stock at a certain price. For example:

• If you bought the October 40 put on the iShares Silver Trust, you can sell the ETF for $40 at any time between now and the third Friday in October, no matter what the ETF price is.

• If SLV doesn’t go below $40, your put would expire in October worthless.

• If SLV is below $40, no matter whether it’s trading at $39.95 or $20, you can sell the ETF for $40.

No worries if you don’t actually own the ETF. You can still use the puts to protect the value of your coins or other silver investments, because the value of the puts will go higher even as iShares Silver Trust decreases in price.

Keep in mind that one option contract controls 100 shares, so if you see a quoted price for the put of $2.90, it will actually cost you $290.

If you don’t like trading options, then at least place a trailing stop on any of your silver stocks. And stick to them. Don’t cancel them as the price falls, because you decide you want to hang on to the stock and just know that it’ll rebound.

Trust yourself that you placed the stop for a good reason. A stop is designed to remove the emotion from the selling decision.

A New “Golden Age” for Silver?

Perhaps we’ve entered a new “golden age” for silver. Maybe the metal does go to $100 an ounce or higher. But if you’ve made some money on the run-up, it makes sense to protect your hard-fought gains.

After all, I’m sure many of you bought life insurance when you were young and at the peak of health. This is no different.

Where are we in this cycle? I’d argue we’re right around the "Thrill" area -- maybe a little past it. As we approach the "Euphoria" stage, it’s time to start playing a little bit of defense.

Marc Lichtenfeld is a Senior Analyst at InvestmentU.com. See related articles by Marc here.