Fear and Herd Mentality Rule the Markets
During last week, the price of silver plummeted. How should we react?
My first comment is “fear not”. The stock market works in strange ways with mania and rushing to the latest and the greatest trade ruling the short term price of whatever is the current rage of those traders between the ages of 18 and 29.
Recently, the favorite has been the price of silver. When is the last time you saw something rise in price 150% in a relentless rage over a very short period in time? Think for a moment if the demand for silver has risen 150% in 2011. I think not.
Some Factors to Consider
The Historical Relationship between Gold and Silver
There has been a historical relationship between the price of silver and the price of gold. Because of current economics, this ratio has tended in recent years to be out of whack. I have previously commented that this ratio is not of current relevance. Yet, it has been a mantra of silver traders who expect silver to approach $90/oz in value, which would be the expected price of silver based on this outdated comparison.
If silver reached $90/oz in value, the buyers of silver would not be buying silver. It would be too expensive.
Another rationale is that gold is supposed to reach $1,500/oz (which it recently has), then $2,000, then $5,000 in value. The thinking is that if gold reaches $5,000 in value, then its poor cousin silver has an enormous rise in value coming.
Gold may increase in value, but not so quickly and not so dramatically that silver should increase in value by 30% every month. Some moderation in thinking is needed here.
The Real Reason for an Adjustment in the Price of Silver
In the past few weeks, regulators have become concerned with this mania regarding silver. As a result, the margin requirements to buy silver contracts have risen in four successive recent announcements. Traders now have to put up far more money to buy a silver contract than they had to last week, or last month. The latest new margin requirements came into effect at the end of last week.
All of a sudden, these genius traders had to put far more money into their trades than previously. Guess what happened? They had to sell part or all of their holdings, and quickly. Otherwise they had to come up with lots more cash in a big hurry.
It used to be that a trader bought a few contracts in a commodity.
Now the big houses buy enormous quantities of contracts – far exceeding supply of the metal itself. Like with all derivatives, it has become a pure gamble involving enormous sums of money. When they have to sell, it hurts because the buyers disappear quickly – most of the recent buyers were these same traders that are now sellers.
Therefore the price drops quickly and those geniuses that had loaded up on silver contracts expecting the price to rise and rise and rise, lost a lot of money quickly. That’s ok – they will make it up on the next mania, and there always is another mania.
Conservatism and realism are not in the vocabulary of traders. It is only follow the latest trend and jump on the bandwagon with both feet.
The Reality of Silver
The demand for silver continues to rise. China, India and other BRIC countries continue to have growth in their economies. The USA and Europe are gradually recovering, and the recovery increases demand for silver.
Silver continues to be used in more and more processes. This is the interesting part. When Kodak film consumed so much silver and then digital film essentially replaced processed film, everyone thought the demand for silver would vanish. The opposite has occurred with so many new demands for industrial uses.
The demand for silver will continue to grow and the supply of silver continues not to meet demand. New sources are not plentiful and it takes a long time for a discovered deposit to become a producing mine.
Silver remains a good place to invest, and will for the near future.
The Market has Always had Adjustments and Always Will
There has never been a time when the market continued in a straight line for a very long time. Dramatic rises always have corrections. This dramatic drop in the price of silver is just that – a normal and needed correction.
Examine any market or any part of the market, in any historical context. Rises range from gradual and prolonged to a dramatic rise such as we have recently seen in silver. It is a universal truth that corrections (falls in value) are always much quicker and much more dramatic than rises. Another truth is that the quicker the rise, the more dramatic the fall.
That is what we saw in silver this past week.
The Seasonality of the Stock Market
If you examine the value of your portfolio in almost every year since WWII, in the Spring prices moderate and usually fall. May/June is almost always the lowest point in the year. What happened last week was quite normal and not alarming.
Conclusion
The demand for silver will continue. The demand for commodities will continue. But perhaps with a little more realism and a little less wildness
