Friday, March 11, 2011

The Bubble With A Silver Lining - Ryan Jordan


With silver up roughly 100% in six months, many professional traders may find themselves wondering when to short the white metal. After all, nothing shoots straight up forever, right? Even as a silver fan, I get a little nervous looking at the price action, and wonder the same thing: is silver due for a major pullback? When this seasonal period of strength is over, might silver do what it did in 2008 or 2006 and make a very sharp 30% or 50% drop?

I ask myself this question, always respecting the need to play devil’s advocate with my own mind. But, then I ask myself other questions. Such as: have any of the structural problems facing the developed world’s economies been solved? My answer is no. Has the average person put even 5% of their money in physical silver? No. Are savers being compensated for inflation risks, or is the Fed raising rates? Both no. From these answers, it is safe to say that the silver bull is far from over. The silver price rise (at least so far) is not about industrial demand. It is about people making a start toward redefining the nature of money, wealth, and savings. This redefinition- believe it or not- has only just begun.
What Part of “Its Over” Don’t You Understand?

Much has changed in the world since 2008, the last time there was a serious pullback in silver. For one, savers have been stiffed with zero percent interest rates on their savings for over 2 years even as those same savers watch the price of many other items move up close to something like 10% a year (gas, health care, & education costs, to name three). Government paper or even equities are not the best inflation hedge. Two, many are coming to realize that we are not experiencing a “typical” recovery because we may have finally reached debt saturation in the developed world. We are not going back to the old normal. Three, since 2008 new holding companies in silver have appeared which give everyone with an online brokerage account unprecedented access to the white metal. Fourth, increasing evidence out of China shows that after having dumped millions of ounces onto the world market for years, the Chinese are changing course and buying silver hand over fist. (This development alone deserves an entire book, by the way.)

Finally, I am struck by how much online discussion there is about naked short selling or other kinds of paper shenanigans at bullion banks. There are now several lawsuits over the pricing of silver, for example. At least at the margins, people are questioning accepted price discovery mechanisms in silver and taking delivery. Many other people understand that floating exchange rates are not synonymous with a free market in gold and silver- an important point. Just as with any number of efforts to cap precious metals prices over the last several centuries (the most recent one being the London Gold Pool- which was overrun first in 1968, replaced with a two tier system, and finally ended in 1971) current attempts to cap the price of gold and silver will end in failure. Put another way, many banks or warehouses in the precious metals industry are susceptible to bank runs- which is how I view the end of the London Gold Pool and official convertibility in the early ‘70s. Understandably, bankers who defend or attempt to maintain certain price capping arrangements will do everything in their power to ignore the problem, or to pretend that what is happening isn’t real. Small, retail investors should not be fooled, however, and should continue to take delivery of metal. I might add that bank runs are not the end of the world. Painful, yes, and we all have some tough reality ahead of us. But apocalyptic? Well, only if you are a banker.
Silver and Deflation: Not What You Think

Which brings me to another difference between early 2008 and today: the number of online discussions focusing on economic collapse, on “the end of civilization,” or other fears of a dystopian future. This is an example of Bob Prechter’s “social mood” turning dark as we enter the great downsizing of the West. I am not so sure that the world is going to end in December of 2012, or that all of the nightmare scenarios presented online will come to pass. However, it is worth pointing out that if our global economy moves in reverse, back to the less-levered environment of even fifty years ago, let alone one-hundred years ago, then the exchange value of gold and silver will skyrocket (likely right along with other, select tangible assets). In the nineteenth century, for example, a gold coin could buy a few acres worth of land. It was not that long ago (early 20th century) that the value of the world’s silver coin would have equaled at least 10% of the global monetary base. In today’s terms, that would put the value of silver at between 500 and 1,000 dollars an ounce, since most people estimate the global monetary base to be in excess of 10 trillion dollars. Even if other assets deflate, you will probably find physical silver increasing its relative purchasing power for other assets- regardless of the currency in use.

I am sure that many, many people will find themselves unprepared for some of the difficulties ahead. I am also positive that many Americans will continue to experience conversion moments where they view their once unrealistic expectations regarding economic growth as incorrect. Americans will embrace some variant of austerity in their own lives, and they will reject aspects of the leveraged casino, infinite-credit-economy that we all have lived with for the past several decades. This rejection of debt could not be more bullish for precious metals- which are money after all, not mere commodities. And in the next liquidity squeeze- sometimes referred to as deflation- the monetary metals will not go down. I hope people were paying attention to the price action of gold and silver last spring during the “fat finger” event- both metals finally achieved the safe haven status denied them in the fall of 2008. The fact that gold and silver have risen so far so fast in this “recovery” is likely setting the stage for an even larger, more dramatic move, when we find ourselves racing down the other side of Bubble Mountain.
Silver, Inc.

Many silver commentators have correctly pointed out that silver could behave like a hot internet stock in the next few years, putting its amazing price performance in the last bull market (1940-1980) to shame. That would be quite something if true, since silver went up 100 times in the mid-20th century. And yet the claim that silver might be able to move up 10 times from here (without the world ending) certainly seems possible given the wide ranging access investors have to silver through brokerage accounts. In addition to the fact that large parts of the world (like Russia and China) can now take part in the silver bull- unlike thirty years- it is also far easier for Americans and Europeans to invest in silver today than three decades ago. In the 1970s in the U.S., for example, investing in silver involved the relatively cumbersome process of tracking down silver certificates, or buying coins or bullion. Not so today. Now, all you need is an internet connection and you can buy silver online- either with holding companies like Sprott Physical Silver Trust, or with entities like Although there is no substitute for physical silver for all sorts of reasons, these types of holding companies are taking silver off exchanges. They are not paper silver. The increase in this kind of exposure to silver for average investors means that a price rise in the market cap of Silver, Inc. could easily move from the roughly 35 billion dollars today toward the 200-500 billion market capitalization of an Apple, Google, or Exxon Mobile.

As far as the silver market being primed for a further pullback beyond today’s action (March 10), I have to remind you (once again) about the behavior of silver from 1977 to 1980. This was the last time the silver rocket made an appearance in the sky above Wall Street. During those three years, the price moved from about $4.50 to $49, with no pullbacks greater than 15-20%. And these pullbacks were extremely brief in duration. Of course for anyone who was only in diapers in the late 1970s (or not even born), you may want to think about the Nasdaq bubble between roughly 1995 and 2000. How easy would it have been to short that market, or to find pullbacks? Not very. While investing in silver is not for the feint of heart, and should not be attempted with leverage, if you have yet to buy any physical silver you may be getting a discount this week or next. I think this financial system has one great bubble left in it, a bubble with a silver lining.



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