This week saw
the type of downside volatility in the precious metals market that will be
remembered for years to come. For those of us who have been long gold, and
silver in particular, the memories will not be pleasant. While many had been
expecting a pullback in silver, when the violence did come it was
nevertheless shocking. Silver shed one third of its value in less than one
week. And while gold was pulled down by the general sell off in all
commodities (oil, copper, coffee, etc.) the yellow metal shed only 6.5%
during the carnage. Those mild losses should remind us that gold is not just
another commodity, but has monetary qualities that tend to smooth out
volatility. But will silver survive the vicious downturn?
First,
despite all the valid reasons that, in an era of perpetual quantitative
easing, silver had become an attractive asset class, it had become clear in
recent days that it was overbought. Leading up to April 28, the price of
silver rose by more than 150 per cent in U.S. dollar terms over the prior
year. On Wall Street momentum always attracts momentum, and as a result, the
ascent accelerated in April, with silver rising 31 per cent from April 1 to
April 28.
A
"hot" commodity tends to attract leveraged speculators. As a
result, the rise became more technical than fundamental. Its recent sell off
should be viewed on the same terms.
After an
exponential rise, supercharged by leveraged speculators, silver was bound to
attract the attention of short sellers. In addition, silver speculation
became more expensive as the Chicago Mercantile Exchange raised the margin
requirement for buying silver futures five times in just one week! Factoring
in all of these increases, the last of which becomes effective this coming
Monday, the cost of owning silver futures contracts will have increased a
staggering 84 per cent from the beginning of May. The rationale behind these
moves requires serious inquiry...which I will leave to more informed
columnists. But the results were predictably dramatic, as many leveraged
players were forced to liquidate.
In addition
to these technical catalysts, other factors contributed to the decline this
week. Facing pressure from domestic exporters who complain about an overly
strong euro, there are signs that the ECB is losing its commitment to
vigilance against inflation. This has led to speculation that the U.S. dollar
could strengthen for the remainder of the year. This could adversely affect
the price of precious metals. In addition, with private sector unemployment
rising in the United States, there is a risk that the U.S. economy could be
entering a second, or double dip recession. This would lower the risks of
overt inflation and dampen the industrial demand for silver.
But as far as
long term fundamentals are concerned, the case for precious metals remains
intact. First, as long as the Federal Reserve and other central banks around
the world continue to treat fiat currencies as monopoly money, investors will
be seeking alternative currencies as a hedge against inflation. But until
bank lending to consumers and businesses increases dramatically, the dangers
of hyperinflation will remain largely hidden from the broad swath of
investors. As a result, silver's upward price movements will be vulnerable to
panic selling.
But from my
perspective the biggest driver in purchases of silver and gold is likely a
fear of a meltdown of the dollar and a collapse in the financial system.
There are few signs that these fears have abated with the selloff in silver.
The U.S. dollar is still standing close to a 3-year low against the dollar
index. If more rumors spread that the dollar may lose its reserve status, the
greenback could plummet. It is perhaps this perceived risk that has provided
the majority of the force behind increases in precious metals over the past
year. It is important to remember that the fundamental strength of metals
attracted the speculators, but speculators did not create the bull market. It
is my feeling that it will endure without them.
While a
threatened recession and a stronger dollar should deflect inflation
expectations in the short-term, the longer-term risk of a debt crisis
spreading into a currency crisis remains. Indeed, the risks of a currency
crisis are increasing. For investors who share this view, and who can
tolerate the volatility, the reduced prices of silver may be attractive.
John Browne
Senior Market Strategist
Euro Pacific Capital, Inc.
20271 Acacia Street, #200 Newport Beach, CA 92660
Toll-free: 888-377-3722 / Direct: 203-972-9300 Fax:
949-863-7100
www.europac.net
For in-depth analysis of this and other investment topics, subscribe
to Peter Schiff's
Global Investor Newsletter. Click here for your free
subscription.
Click here to download Peter's latest Special Report: My Five Favorite Gold & Silver
Mining Stocks.
Be sure to pick up a copy of Peter Schiff's just-released economic fable, How an Economy Grows and Why It
Crashes. Click here to learn more
and order.
|