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The Silver "Reverse" Bubble of 2008

As an investor, speculator and researcher in the silver market for over 5 years, I have to say that I am (temporarily) stunned at the extraordinary recent events in the silver market this summer. It is an incredible contrast...

  • In Physical silver....there are shortages and delays everywhere. The U.S. Mint even made the recent announcement that they would essentially ration the issuance of Silver Eagles. I think that Jason Hommel has done an excellent job documenting the problems with physical silver supplies and delivery at the retail level. Check out his recent article at www.SilverStockReport.com.
  • In "paper" silver (such as in silver futures and silver-related investments such as mining stocks and ETFs) the extreme opposite seems apparent. The price of silver in the futures market has in recent weeks been decimated.

It is a incredibly stark contrast...physical silver has growing demand and shrinking supply while paper silver's price gives you the opposite impression. Silver hit a recent high (March 2008) of about $21 yet is being pummeled today (the morning of 8/15/08) to the $12.90 level (a pullback of almost 40%). What is behind this extreme anomaly? What is the reality? Why the apparent madness in the silver market?

Yes...it is the summer slow season. Traditionally it is a thinly traded market and silver typically corrects at this time of year. Usually, the corrections are sharp and it is not uncommon for silver to pull back 20-30 and even 40%. Silver has had pull-backs in price of about 40% several times in recent years. The most prominent corrections have been Summer 2006 (during an election year) and now (again during an election year). Winter and summer are typically weak seasons for silver while Spring and Summer are typically strong.

Silver has been zig-zagging upward since the beginning of the decade and has rewarded patient, disciplined investors. Even after this extreme correction, silver has still tripled since 2000. It is important to put things in perspective. Think about what has happened from January 2000 to August 2008 (calculating from highs & lows in 2000 to today):

  • Gold - UP OVER 200%
  • Silver- UP OVER 210%
  • Oil- UP OVER 600%
  • General commodities- UP OVER 200% (that's a minimum)

Meanwhile (after a full 8 ½ years)...

  • The Dow- DOWN about 1%
  • Nasdaq- DOWN 51%
  • S&p 500- DOWN 13%
  • The Dollar- DOWN 40%

I think the last 8 and a half years give you a strong indication about the coming years since nothing has fundamentally changed with these markets. If anything, the fundamentals have strengthened. So what explains the recent pounding that silver (as well as gold, oil and other commodities, etc.) has experienced? It seems very unusual and quite suspicious. First let's remember something very important...

The short-term can be irrational while the long-term is much more rational.
Stay focused on the long-term because the short-term can fool you.

Everyone is stampeding out of commodities in general because they think (wrongly) that the "commodities bubble has popped". The extreme selling is coming from two sources:

1. Investors and traders selling off their positions for various reasons (they are bearish, etc.). "More sellers" than buyers will make prices go down and this is a natural market event. This is coupled with...

2. Artificial intervention. Either the government or large private entities (that government either sanctions or allows) or both intervene to exact certain outcomes. It is no coincidence that this happens during an election season as well as during thinly traded markets (such as the summer time).

I understand (and embrace) reason #1 but I strongly condemn reason #2. Frequently, reason #2 is a catalyst for reason #1. The unfortunate reality of today's markets is that government (and entities that it works with) are players in the financial markets in both obvious and subtle ways. It used to be a "referee" but know it is both "referee" and participant.

Look at the "recent strength" of the U.S. dollar (which is a major reason given by the financial media for plunging commodities & precious metals prices). A few weeks ago the U.S. Treasury Secretary essentially admitted that the government would intervene to protect the dollar's decline. Then...amid many headlines about a bad economy...the dollar rallies tremendously for apparently no fundamental reason. This scenario is best explained in James Turk's recent essay at www.goldmoney.com entitled "Mystery Solved." Of course, it is no coincidence that a "strong dollar rally" is the catalyst for falling prices in oil, gold, etc.

In recent years, a host of government officials (starting with Alan Greenspan) have indicated that the government can (and will) intervene to exact outcomes that they feel are beneficial for the economy and financial markets. These interventions work in the short-term but they tend to fail in the long-term. Let's keep this in mind...

In the short-term, government intervention can usually "win" over the market.
But over the longer term, it is the market that usually wins.
5,000 years of economic history bear this out.

During this summer, government action has worked and helped to (temporarily) influence the market to get the prices of commodities (especially precious metals and energy) down. Sometimes a government action is not necessary; just the threat of government action is enough to influence the market. This leads us to understanding how the government can have a major, short-term impact on prices. The impact can be purposeful or accidental. IN any case, it is time to understand what a bubble is (then you will see what a "reverse bubble" is).

In recent years, there has been a lot of talk about BUBBLES. There has been plenty about the Internet & Tech stock bubble of 2000-2002 and the Housing Bubble of 2005-07. Then there was the talk earlier this year about the "oil bubble" and the "commodities bubble". People that never noticed the bubbles in stocks and housing all of a sudden saw one in commodities. LET'S GET THIS STRAIGHT. You should know the difference between what is a "bull market" and a "bubble". Then please explain it to the politicos and pundits out there confusing the investing public. Here is the major, simple difference between a bull market and a bubble:

A bull market is a NATURAL event. A bubble is an ARTIFICIAL event.

A bull market occurs when there are more buyers than sellers of a particular asset (stocks, metals, etc.). This is a healthy and natural event driven by demand and supply. Bull markets can last a long time; years or decades. There is nothing wrong with a bull market. A bear market is when demand & supply manifests itself as a market where there are more sellers than buyers. Got it?

A bubble is an artificial event in that the market is injected with an oversupply of currency and/or credit. Currency and credit in our current economy originates from the Federal Reserve (America's central bank; a governmental entity). Since 1995, The Federal Reserve has been expanding the money supply at double-digit annual rates. Since the middle of this decade, most of the world's central banks (translation: governments!) have been increasing their respective money supply at double-digit rates. The more you produce of something then the less each individual unit of it is worth. This is why things of more limited supply (food, energy, precious metals and other commodities) have seen their prices more than triple since the beginning of the decade.

Therefore, a bubble is an artificial event where there is intervention (more credit, etc.) in that particular market which then dramatically warps demand and supply as the price of that particular asset is driven higher (inflating the bubble; also called a "boom"). Usually, what punctures the bubble is that the artificial demand over-stimulates supply which is when the bubble finally pops. The oversupply results in a recessionary condition in that particular market. This is exactly what happened in recent bubbles, especially the housing market. That market is still experiencing an excess inventory of homes along with record levels of foreclosures and defaults. Many homeowners now have mortgages that are greater in value that the property itself. Then you have seen the wave of defaults on mortgages which became the "sub-prime fiasco" which in turn harmed the holders of these demolished debt instruments such as banks and brokerage firms. Now...how about "reverse" bubbles?

As you can guess by now, the "reverse" bubble is an artificial event similar to the typical bubble but it is the direct opposite. In the bubble, the price of the asset in question is driven artificially higher. In the reverse bubble, the price of the asset in question is driven artificially lower.

This is what is happening...right now...with silver (and to a lesser extent, gold). Even though there are acute supply problems (delays and shortages) with physical silver.

There is artificial selling (extreme "shorting" by a few, large entities) coupled with panic selling which is forcing prices of silver down dramatically. In the past few weeks, silver fell through its 200-day moving average (DMA). To get a feel about how the huge short position in silver has been extreme, check out the recent essays by Ted Butler at www.investmentrarities.com. He has done a fantastic job in painstakingly documenting the major forces affecting the silver market in recent years.

This summer, silver's correction became more extreme than usual. Silver was forced past its 200 DMA and it went under $16. I was a buyer at this level. Then it went to $15 and I was still a buyer. The next "line in the sand" for silver after the 200 DMA was the 50-week DMA and silver fell through that. Again, I was a buyer. The next level was silver's cost to produce it (for silver miners) which is about $14 per ounce (given today's mining costs). It then fell below that! In other words, silver's price is at this moment cheaper than it costs to mine it (you got it....I was buying again). Gee...why mine silver at all if it is cheaper to simply buy it at the futures exchange for much less?! THE PRICE OF SILVER HAS BEEN FORCED TO BELOW COST.

The SILVER "REVERSE" BUBBLE is here and now in the summer of 2008. In the same way that a bubble deflates and the asset price comes tumbling down, a "reverse" bubble is like forcing a huge balloon under water. Sooner or later, the artificially low price can't hold and the market will ultimately force the price up to its natural level. Most silver experts (such as David Morgan at www.silver-investor.com and Roger Wiegand of www.tradertracks.com) agree that the near-term natural price of silver is north of $20 and that the long-term price is much, much higher than that. Just for silver to reach its old high of $50 (January 1980) on an inflation-adjusted level alone means that its natural long-term price is in triple digits.

Unfortunately, many folks are panicking or depressed about silver, gold and other commodities. I think that we need to remind ourselves about the legendary Jesse Livermore when he said to be "right and sit tight." Silver, gold, oil and other commodities are on a long, zig-zag upward march that can't be stopped by any firm or government agency. The commodities super-bull market is alive and well because the fundamentals are too powerful to suppress. Don't get fooled or spooked by the irrational and ill-conceived short-term gyrations. Stick with the fundamentals and stay focused on the long-term. I know that I am.


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