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The Bullion Report

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May 18, 2011 in 'The Bullion Report'

Silver's Hard FallSilver's Hard Fall


They say that the bigger they are, the harder they fall and silver has been on a large price move as of late. Capturing what some analysts may have felt was more than its share of the rise in commodity prices,  silver managed to turn back against April’s gains, and more. What was it that made silver climb so fast and then fall so hard? More importantly, is this the end of the road for silver, and gold for that matter?

 

For some traders, there isn’t a straightforward answer when asked why silver climbed much as it did, and towards the end, so quickly. There were also some signs of potential weakness once silver approached $50 an ounce. Since the dramatic drop, I have seen the word parabolic applied to silver’s ascendency coupled with assertions that when compared to other historic rises in the precious metal, we should’ve known better.


The problem with that assumption is two-fold. The first part is the idea that the catalyst for the climb was part fundamental, part euphoria. Yes, traders knew that some of the larger banks and investment houses had short positions but other important entities (namely central banks) have become net buyers of precious metals. This shift has come after years of assertions that gold and silver and the like are wasted assets since you park wealth in them to try to preserve it from erosion. There is normally no cash flow in metals holdings. Gold and silver don’t pay out heaps of interest payments like other bank assets, so the old argument was that the bank should work on acquiring things that keep money working and growing. Now they acknowledge the value in keeping gold (and other metals) as part of reserves to hedge against certain conditions like inflation. That means buying assets which serve as protection from currency devaluation like the one seen in the form of stimulus for the US economy which involved printing money. Enter the central bank as buyer.

Other fundamentals included increased individual investor interest, namely in growing markets like India and China. A lot of this fundamental strength focuses on gold rather than silver, but for the last few quarters, silver started to shine in its own right. The affordability of silver as compares to gold made it an attractive precious metal market to those for whom gold was just a bit out of reach. Percentage-wise, silver had been lagging gold’s price climb so fresh buying interest was sparked by the idea that silver was a sleeping giant.

This kind of hidden price potential was seized on rather violently in April, and this is where the euphoria picked up. All told, some silver contract prices enjoyed a $10 per ounce ride through the end of that month. Then, in less than a week, silver was right back where it started. That kind of quick fall led to an inordinate amount of fear - not just in the silver market but commodities and other precious metals - which sparked a round of what I’ll call potentially panic selling. Now that the dust is settling, it is an opportunity for traders to evaluate the situation so silver and gold will likely see consolidation here. A note about the margin increase from the CME Group on silver futures, the margin change affects longs and shorts, and I see it as a less impactful thing than the fear selling it helped fuel.

Summary


Silver, and indeed most commodities, are obviously on the back end of a large exodus of longs. Funds and other speculators took a lot of risk off the table, but there are a few fundamentals that might still conspire to bring buyers back after any hiatus. The game has changed quite a bit since the historic sell-off of the 1980s. There is a real lack of recovery in housing and employment. Growth will have to be established in these areas before we can see real confidence in other currencies like the euro or US dollar. The Euro zone has its own basket of problems, including inflation, and traders know what investors traditionally turn to under inflation threats – gold. Any rise in gold still precipitates a climb in silver, even if it isn’t at the same rate. I would also suggest that this latest decline will offer what some people will see as attractive price points to scoop up gold and silver. This would be true for a portfolio, coins, or other physical demand. As it stands, some major world mints are already seeing an issue in procuring silver to use for their bullion coins. Demand had previously led to delays for silver Maple Leaf coins and silver American Eagles. If the wait time is shortened on this latest dip in prices, I see no reason why buyers won’t take advantage of any new availability. Silver may have fallen hard, but I think it will pick itself back up before the year is out.

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Disclaimer: The prices of precious metals and physical commodities are unpredictable and volatile. There is a substantial degree of a risk of loss in all trading. Past performance is not indicative of future results.