Is silver a bubble? Or did we just experience a blow-off top from the highs a few weeks ago? This article is derived from a conversation I had recently in replying to an article on the financial website Seeking Alpha written by CFA, Michael A. Gayed called Silver: From First to Worst. I always enjoy my conversations with Michael as he participates in the conversation with good analysis rather than claiming myths about gold and silver like others with the same designation.
I am not usually challenged when it comes to making comments on the negative articles that describe gold or silver as a “bubble” but in this article I enjoyed the exchange with Gayed and another poster named JasonC, even though both use the term “bubble” to describe the status of silver.
It is much easier for you to go to that article and read the exchange than for me to copy it entirely here. Read the article and then do a search on the page for my name. I have included some of the exchanges below that I thought most pertinent debating whether silver is a bubble and crashed for good or whether this is just a pullback we are presently experiencing and higher prices are to come.
My main point in my replies is that silver is NOT in a bubble, but just consolidating, even at a possible lower price as the dollar rises versus other currencies, before it’s next leg up. Silver could fall to below $30 an ounce during this time, but not too much below that. Dollar cost averaging into a position makes financial sense as you will read via the exchange which I enjoyed. The fundamental reasons for owning silver haven’t changed.
I agree with your premise, but there has not been a crash in the U.S. dollar, so as of right now there is no “once-bitten, twice-shy” effect for currencies.
Michael Gayed said; “but there has not been a crash in the U.S. dollar…”
Hi Michael, I appreciate your conversations with the posters. I do recall having exchanged thoughts previously with you.
To your comment; what you are referring to is the dollar not crashing because of what it is priced in (Euro, Pound, Yen, Canadian dollar primarily). But all of these currencies have crashed vs. gold have they not? With the U.S. dollar leading the way at over 400% the last 10 years. Gold doesn’t change, but what it is priced in changes.
They are all currencies on the sinking ship, each taking their turns running from one side of the ship to the other, but not escaping the rate at which the ship is sinking.
Only government austerity, reduction in government departments, a Constitutional amendment restricting Congress to their taxable means, along with reducing the budget (presently at 14.3 trillion and soon to be increased) with severe penalties to Congressmen if they don’t adhere to it (like loss of income/job/paycheck) will stop the sinking here and elsewhere.
Since none of the above will happen, you own gold and silver as insurance against the unsustainable outcome, only slowed temporarily by Fed QE, until said time when the “behavior” of the masses realizes what’s going on. Then gold and silver will enter the 3rd stage. This is your long term outlook my friend.
Unfortunately.
Doug – great to have you share your insights again. There is a difference between a bear market and a crash. A crash is mostly an event that occurs over a very short period of time, and which is often market by extreme volume and volatility in that small window of time. So I will agree that clearly Gold has been in a bull market/Dollar has been in a bear market for over 10 years. However, this is not a “crash.”
As to long-term outlook – I hope your crystal ball is clearer than mine!
I guess we are talking about whether 400% or so represents a crash (at least via the gold price). I can understand more from where you are coming from. Yes, the dollar has not crashed per se.
In 1929-1933, there was no crash either, but a run on the banks. However, what saved the banks was in 1934, the dollar was devalued downwards by 60% or so as the government decided to stop redeeming Federal Reserve Notes in gold and subsequently taking the gold price higher from $20.42 to $35 an ounce (I forget the exact numbers and percentages as I am too lazy to open my book – but you get the picture).
Bernanke in his 2002 deflation speech claimed that this action during that era was good. But the 1929-1934 era was when FRN’s were tied to gold. Bernanke cannot take such action today. He cannot devalue gold (except through the banks doing his dirty work, which is a forthcoming article I am working on).
What he can do is quantitative easing to fight deflation (credit contraction), and this is what is keeping the banks afloat as they mark to fantasy their assets with the full blessing of the FASB.
I’d like to hear your defense of the banks in your analysis as to whether gold should be a part of a diversified portfolio. But perhaps you might want to wait till my article is finished (smile).
Shoot me your email to info@buygoldandsilvers… and I’ll send you a copy of my book where in Chapter 4 I dive into the banks among other things (like the Fed’s balance sheet). I have a different take than most as to the “how” we will get there, and the timing. Personally, I am happy to see the pullback in gold and silver. It allows my clients to buy the physical at a lower price.
Whether my crystal ball is clearer, I don’t know. But my analysis of the banks paints an ominous future, especially with over $4 trillion of sub-investment grade derivatives coming due in the next 5 years with no counterparty but the Fed.
It’s not easy putting the pieces of the puzzle together, but you won’t find me using conspiracy to prove a point either. As Jack Webb used to say; “Just the facts…”
On a side note, my next book is about righting the ship and yes, it will include behavioral analysis, something I too try and understand (I’m sure you’ve read Extraordinary Popular Delusions and the Madness of Crowds).
Cheers…
P.S. I remember last time Seeking Alpha erased our conversation. I am taking screen shots so as not to lose the exchange. I do appreciate any insight I may be missing as I can’t possibly claim to know it all…
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Second Exchange
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Looking at a chart of SLV since it came out 5 years ago, I notice a moderate bull market before the financial crisis, peaking along with the dollar’s bottom around Bear Stearns day, then chop, followed by a 50% crash during the financial crisis within 3 months. That was followed by a retracement bull in line with stocks and other risk assets, which continued through August of last year, roughly doubling off of the lows.
Up until that point, silver was behaving like a commodity and a risk asset and a dollar value play, all sensible enough. I note that at that point, the price of silver was around $18 an ounce against an average current cost of production of $15 – in other words, it may have had some modest froth from recent performance but it was fundamentally in line with underlying economic realities.
Starting last August all of that changes. It goes on a bubble bull market tear at unsustainable rates of increase. The move is remarkably consistent in rate, with minimal chop, and parabolic blow off volumes, rising relentlessly. This is a classic bubble chart. It is a signal not of fundamental anything but of trend following, people piling on in a positive feedback process unmoored by reality of any kind.
And it peaks and then crashes. Like every other such trend following bubble before it in the history of the world.
Looking at where the open interest is in the options, I expect we will have sideways chop at high volatility through May expiration. Then I expect the move down to resume, testing $25. I see no economic reason for silver to stop in that process before reaching and perhaps passing through, to the downside, its average cost around $15, but speculators can do what they like with speculative vehicles, and nothing is certain about it.
What isn’t debatable is that from August of 2010 to May of 2011, silver was in a classic bubble and it has popped. That is already one for the history books.
One man’s opinion…
May 11 08:04 PM Reply ! Report abuse +2 0 -
So what you are saying JasonC, is a metal that did not reach it’s all-time high is in a bubble?
Ok…
Answer me this…if you buried an ounce of silver in your back yard 10 years ago, and dug it up today, is it the same silver? If so, then how can it be in a bubble? It is what it is priced in that changes.
Yes, silver was due for a pullback. Ir doesn’t mean, as others have said above, the fundamentals for the weakness of the dollar and all other currencies have changed.
May 11 08:26 PM Reply ! Report abuse +2 -2 -
The value of everything in existence changes all the time.
Because it is a value and not that thing, and values depend on the entire complex of needs of all other human beings, on everything they own, and everything they need or want, on all technical possibilties, and even on every passing fad. And no, it doesn’t matter what you measure with, relative values of everything are changing all of the time.
The recent past in silver shows the behavior of a typical commodity being traded in step with other economic developments, up until August of 2010. And then it stops trading in step with other economic developments, and trades in a new way.
And an entirely recognizable one. The way that trend following, positive feedback processes always go, as a matter of mere mathematics, and always will go.
The annualized standard deviation becomes a modest 31%. The mean becomes a 278% annual rate of increase, completely dwarfing the volatility, and thus making the apparent future return appear a certainty. Kurtosis of returns drops to a near Gaussian 4. There are 3 up days for every 2 down days, instead of being nearly evenly spread. Compare and contrast – in the prior 4 years, the mean increase was only at a 12% annual rate, the standard deviation was 38%, kurtosis was a long tailed 8.9, and up days outnumbered down by only 18%, not 50%. The gradual uptrend was punctuated by downs and volatility was significantly larger than that trend, making for no apparent certainty in the direction of the return a year out.
This change is the statistical signature of every bubble since the South Sea. Men see an asset rising in price, everyone wants in and no one wants out, this reinforces the trend, volumes rise along with past performance as more and more seek the same sure thing, until the price has become utterly unmoored from economic realities and men are merely trading to sell to the next entrant. When prices crack after such a move, there are no fundamental buyers whatever. The first price they’d bid at was left behind months ago, five exits back. Every holder of the asset is a trend follower – that is how and why they got in.
And as soon as an asset owned exclusively by trend followers changes its price trend – air pocket, no bids, crash.
Every time. Law of nature.
May 11 09:41 PM Reply ! Report abuse +1 -1 -
I beg to differ with your crash analysis. The fact the CME stepped in and raised the margin requirements had much to do with it. In fact, they did it 3 times. Not once. Not twice, but three times.
This begs the question…why? Why silver? Why now? I think I have put together the answers.
But to compare silver to the South Sea bubble, tulips or other manias is not fair. Sure there was a run up in price. Sure anyone wjho follows charts knew there would be a pullback. But silver is both a commodity and money. Silver was the law of the land money in the U.S. The bankers didn’t like that the average person who dug silver up could go to the bank and mint their own coins, so they devalued it in favor of gold. Then they got rid of the gold exchange. Then they got rid of the gold.
You have to realize, the Federal Reserve Note has 40 short years of existence without a relation ship to gold. Silver a little longer. The Fed would love for gold and silver to disappear as they always represent truth of currency purchasing power. From 1980 to 2000, it showed people put more faith in FRN’s. Today, that can hardly be claimed. The future? We shall see….but I am confident of my research and I can do simple math.
I had zero clients sell their silver with this last pullback. I have had many more new clients who are dollar cost averaging in, hoping for a lower price because they know the future price is a given because of government and Fed policy as well as bank shenanigans.
May 11 10:01 PM Reply ! Report abuse +2 -2 -
Allow me to take an alternative view on the margin requirements issue here. Assume that bubbles are formed through excess speculation (they are as history tells us). That excess speculation is expressed in the form of margin in the high flying investment, as investors borrow at a cost of capital under the belief that they will earn far higher returns.
If the argument being made is that increasing margin requirements caused the crash, then you’re basically saying that the demand for Silver had been driven by margin…which in turn is the expression of speculation…which forms the bubble.
I think this point is largely lost on investors. There is a claim of “manipulation” because margin requirements were increased, but in reality if the upped margin did cause the decline, its because there was so much margin and borrowing already occurring that it formed a bubble like move. What occurred, then, was a removal of a portion of borrowing that was used to buy Silver.
May 11 11:57 PM Reply ! Report abuse +2 0 -
I don’t write about things unless I am convinced of it Michael. That’s why I never talked about the alleged manipulation by J.P. Morgan in any of my articles. However, would you agree it to be highly unusual to increase the margin requirements three times in just a couple weeks? Is there precedence of this in any other commodity?
Speculators, as you know, will always chase what’s hot and drive the price higher and quicker than would otherwise be the case. This can create the potential for an immediate pullback, but it doesn’t necessarily mean the bubble has popped. The data tells me it clearly hasn’t. For me, higher returns are a given despite what the CME does whether or not it was in conjunction with J.P. Morgan and company behind closed doors.
Again…I have no one selling. And the premiums to buy the physical keep creeping up.
May 12 12:11 AM Reply ! Report abuse +3 -2 -
Doug – the swings became wilder, volatility spiked, and the trend broke. All greatly increased the risk in the positions, and intermediaries placing trades for others need to protect themselves when that happens.
Specifically, in the 182 trading days from August 2010 through April 25, 2011, the annualized volatility of SLV was just 30.3%. A typical daily move was 1.9% of the underlying. The trend was to increase 3.6 fold per year. In the last two months of that period, the volatility fell further, to 27%, and the trend accelerated to a 7.4 fold increase per year. Notice, the exchanges did not increase margin requirements at that time.
Then on the 26th, SLV fell 3.9% in a day – a 2 standard deviation move. The following day it rose 6.7% – a move of 3.5 standard deviations. The exchange moved to increase margin requirements.
In a 12 trading day period, the average move jumped to 6% of the underlying. Annualized volatility in this period is at 97%. In the same stretch, instead of a trend that was doubling every 4 months as in the run up period, the mean return in this period is enough to cut the price in half every month and a half, or 8 times in a year.
Clearly, a much larger margin is required for any asset showing 97% volatility and dropping on a half life of an eighth of a year, than one showing 30% volatility and increasing smoothly.
The pace of the average increase in the final months of the run up was hopelessly unsustainable. This is characteristic of bubble tops – a “blow off” phase.
Those buying silver in that period were completely indifferent to the price. They believed they knew the direction, but did not care how high it went. This is also characteristic of bubbles. Level traders will have some expected value or price they think an asset is worth (which can certainly move with time, but gradually). When the price falls below their expected level, they become more eager to buy it; and if it rises above their expected level, they will sell (perhaps partially or gradually to be sure).
But a trend follower has the opposite attitude toward the price. Higher prices encourage him that he is right about the direction. Lower prices have the opposite effect, and lower his demand for the asset, because he projects a past trend to a lower current endpoint and expects a slower increase. Eventually he may cease to believe in the direction and “capitulate”, though usually only after most of the gains of the previous increase have been surrendered.
When any force moves in the opposite direction to displacements of the price, we say that system has a negative feedback. When instead it moves in the same direction as displacements of the price, the system has positive feedback. Positive feedback systems are inherently unstable. They tend to increase exponentially, increasing in speed, until they suddenly don’t anymore. They are also remarkably insensitive to most small scale external stimulae, if any marked trend is already in place. Negative feedback systems on the other hand tend to be broadly stable – perhaps around a gradual trend to be sure – and adjust marginally to external stimulae, typically dampening their scale.
The statistical signature of positive feedback periods in markets is well known, and silver since last August shows all of them.
You can also detect trend following ownership in the general arguments used to advocate an investment, in the way it is advertized and sold. If people crow that it is more expensive than ever and up huge amounts in a short period of time, you can be sure they aren’t looking for bargain shoppers. If the thesis is about the direction but doesn’t address how much; if replacement, production, or substitution costs are never mentioned; if special circumstances “different this time” are alleged – then chances are you have a trend following plaything. There might still be others trading it more rationally – a good reason to look for the statistical signs mentioned above – but some people are clearly buying it because it is more expensive than yesterday – which is the opposite of economic rationality in everything else.
FWIW…
May 12 05:17 AM Reply ! Report abuse +1 0 -
JasonC, I appreciate your detailed explanation. I think we might differ on what is a bubble and what is a “blow off” as you put it. I can’t say I would use the terms interchangeably.
Back in September I wrote an article recommending those who own paper gold and silver (derivatives of the physical) to sell and buy the physical. A holder of physical, as I write over and over in my articles, cares not that it falls 20% or more in prices on its way to 100% or more in gains.
Silver is a different animal than gold. That’s why in my book, Buy Gold and Silver Safely, I recommended a 75% allocation to gold over silver.
When I spoke to people of late about buying silver, I would tell them the only time I saw charts like this before without a pullback was with uranium. I said pullbacks always come. I have said this over and over in my articles as well. That’s why I was recommending that people dollar cost average into a position, “hoping” the price falls so they can obtain a better overall price.
I like your explanation from a technical point of view on silver and just by looking at a chart one could come to the same conclusion for the short term. But to use the word bubble for silver discounts the monetary aspect that it has enjoyed since the times before Jesus Christ and Judas. Silver is money. What it is priced in can be the only bubble.
Silver is also insurance. In this sense, price becomes less important as the reason for holding it. You won’t find me writing about hyperinflation in my articles, scaring people into buying. I still have faith in America and Americans, but not the government, the treasury, banks or the Fed. I also know math and economics and use the term “unsustainable” when it comes to what our future holds in countless categories.
So whether or not silver pulls back further, I don’t really care. Dollar cost averaging in will get a buyer a good price. Gold is the tortoise, silver the hare. Gold is the main investment as all Central Banks hold it over silver. Silver has the added benefit of it being used as a commodity. But it is also more volatile.
To call silver a bubble you can use that term for only a short term analysis or thinking which you have. But silver, priced at $33.78 presently, is still up 73% the last year and 15% the last month.
How low does your crystal ball say silver will go? Why? How high do you think it can go? Why?
I have trillions of reasons why the price will move higher long term. But I will give you the short term blow off. I have no problem with that. That’s why I wrote an article warning people about buying silver on leverage when it was trading at $27 – $28 an ounce. I’m sure Monex will be getting the same nasty phone calls to the BBB that they received in 2008 during the last downturn. That’s because most investors don’t know what they are doing when it comes to buying gold and silver. They simply just trust the other person on the line has their best interest at heart.
I give Michael credit for his April article calling a top. But of his 86 articles on Seeking Alpha, there was not one on buying silver, going back to March, 2007. Rarely will you find those trained in the system telling their clients to buy gold or silver. It goes against everything they have learned because they still categorize it at the top of the investment pyramid.
Study Exter’s inverse pyramid. That’s what I write about in Chapter 4 of my book, which also includes an analysis of the banks…something that most financial advisors ignore and my main reason for holding gold and silver…blow off tops aside.
Good luck with your “trading” and I appreciate the discourse.
May 12 10:46 AM Reply ! Report abuse +1 0 -
If I may counter this for a moment – my batting average has been quite high in terms of the timeliness of the topics of my articles, and what happens shortly after.
To your point, and this is something I believe few understand – it is FAR easier to bet on mean reversion at an extreme than predict what happens when in the middle. This is because extremes are comparitively easier to notice. Furthermore, my articles do not reflect all of my views, since like you I have many different ideas and opinions, and choose to focus my content on those I believe most relevant to the period.
For me to have written an article on Silver when it was performing similarly ot the S&P 500 would not have mattered because the magnitude of returns would be the same – there is no alpha generating information there. It was only when there was a significant divergence in strength in a compressed period of time did I pay attention.
May 12 11:05 AM Reply ! Report abuse +1 0 -
No problem Michael, I had some issues there where I couldn’t see what I had written but just rebooted. Must have been a cache issue.
I didn’t mean to critique your batting average. Only trying to point out how most (maybe not you) view silver in gold who received their training from reading the various text books to qualify for the designation (CFP, CFA). It is clear to me, that some who have these credentials don’t understand the history of money, let alone what a real hedge against currency risk entails.
The CFP book related to the section on investing is a prime example (at one point I was going to become a CFP, but decided to go a different route once I lost respect for the designation after passing off as advice what the author said about gold. Nothing was written about silver and nothing about historic reference to either.
I can’t say for sure what they taught CFA’s, but I have had these conversations with a few, some of whom agree that gold and silver should be part of a well diversified portfolio, and some, mostly younger, who just criticize it any chance they get.
So again, I apologize for making any reference to something that discounted your other writings. Normally, those who critique silver and gold and call them “bubbles” had never recommend them to begin with and missed out on 10 years of the best asset class possible.
The divergence for the S&P and silver occurred in 2007. Not too many pro-silver articles from the investment guru crowd at that point in time. Heck, CNBC didn’t even start talking about silver till this year. 🙂
May 12 11:37 AM Reply ! Report abuse 0 0 -
I appreciate the clarification and certainly respect your viewpoints. As I’ve stated many times before, I’m agnostic to the investment or the reasons behind why something goes up or down (which helps me to avoid some of the effects of the “narrative fallacy”) – something which I hope followers of my work respect and which results in my views not being like the majority of strategists out there. I think ultimately what’s at issue here is the definition of magnitude. The real divergence and significant magnitude occurred only recently, although you are correct that the divergence began in 2007 – it just didn’t have the same level of outperformance until the last few months before the massive decline that’s occurred recently.
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About Doug EberhardtDoug Eberhardt is a 28 year financial services veteran and precious metals broker selling gold and silver at 1% over wholesale cost. Doug has written a book to help investors understand how gold and silver fit into a diversified portfolio, how to buy gold and silver, and what metals to buy. The book; “Buy Gold and Silver Safely” is available by clicking here Contact phone number for Buy Gold and Silver Safely is 888-604-6534
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