How to Customize that Old Silver Convertible…

Back in July, we at the Residual Income Report recommended investors look at the Coeur D’Alene 3.25% convertible bond, then trading at roughly 65 cents on the dollar, and yielding 5.00% annually.  Our thinking focused on the possibility that gold might run up against a wall at $1000 and retrace before attempting to scale that barrier once again.  We suggested that gold could move sideways for six months before it decided its next move, and there, friends, we were wrong.  It took only three months for gold to leap decisively above $1000 and, as of this writing at least, to stay there.

Regarding silver, which generally moves in tandem with gold, we said the following:

For its part, silver nearly doubled in value between October of last year and June, climbing from $8.88 to just under $16.00 (all figures London Silver Spot Fixing Price). Technically, the silver jury’s still out.  Because although like gold it’s currently in a rising trend, and should more or less mirror gold’s overall price action, it will do so in its own inimitable and radical, silveresque fashion.  There’s therefore little to deduce from recent price action where silver is headed in the short term.

Silver, we concluded, “is not easy to figure.”  But in order not to lose out any upside we suggested purchase of the Coeur convertible.  In the event of a downturn in the precious metals, investors would at the very least have a 5% annual payout.

For those with the sagacity to heed our prescient July missive, who found some inventory and bought it (as it turned out, Deutsche Bank was hoarding the lion’s share – we thank one savvy subscriber who eventually called Coeur D’Alene to find that out) there’s now a boatload of good news – and several interesting new opportunities.

First, the bond, like the underlying stock, is approaching par, up nearly 50% (not including accumulated interest) since our call went out.  For those who want to cash in, the current opportunity is good

1. for those who feel satisfied with a 50% return and
2. for those who believe the dollar is reversing here and may signal an end to the latest precious metals surge.

Here’s the way the dollar looks:

If the U.S. buck is reversing here, then put the lights out on the gold party, because the number of dollar shorts that will have to cover mean a spike of longhorn proportions.  That transmutes to a tremulous tumble in the precious metals, if and when it occurs.  The dollar has now reached its 50 day moving average.  From here, it’s got to move – and stay – above it.

It’s more likely though, that the dollar will take its time reversing, suckering a few new shorts in on the way, before pulling that final, rip-roaring wham-doggie of a reversal and creaming all the unsuspecting newbie dollar bears as it does.  We see it unfolding over the course of several weeks, but be sure: we do see it unfolding.

Listen carefully: there’s another trade in the cards for those who bought the Coeur D’Alene bond and want to squeeze even more juice out of it.

First a look at the Coeur common:

Coeur common formed a neat top before pulling back roughly 20% from its highs two weeks ago.  It looks to be consolidating in the $20 to $22 range, closing a gap that was formed in early October, and from which we believe it will continue its descent along with the rest of the precious metals as the dollar firms.

Specific downside targets include another gap to be filled in the $17 to $18 range, while any move north of $22 would be considered a must short opportunity.

That’s where the convertible bond comes in.

The Coeur D’Alene 3.25% convertible has a conversion ratio of 17.6 common shares, which means that you’re covered to short 17.6 Coeur common shares for every $1000 (face value) of bond you own.  If you bought in July when we recommended, and sold your shares short today, the math would look like this:

• You spent $650 for $1000 face value of bond in July, and

• You collect $353 (17.6 x $20.08 [current price of CDE]) today for each $1000 face value you bought.

• Leading to a net outlay of $297 for every $1000 face value of bond originally purchased.

• Conclusion: you collect $32.50 in annual interest on a $297 outlay, for a yield of 10.9% annually.

The pros call it a convertible hedge.  Not bad.

But what’s more, you have another, equally juicy option:

Instead of holding the bond for an extended period, why not ride the short position lower here and close it out for a profit.  That is, look for the gap at $17 to be filled, and close out the short for somewhere between $2.50 and $3.00 profit on the trade.

Here’s the chart for silver bullion:

All the Best,

Matt McAbby
Senior Analyst
Oakshire Investment Research