What has changed in the two months it took for silver to stampede its way up $15 (a 43% gain) and back?
- Did the Federal Reserve raise rates?
- Did the Federal Reserve threaten the market with rate hikes?
- Did the housing market rebound sharply, generating an expectation for higher rates?
- Did inflation expectations adjust sharply?
“No” answers all of the above. In fact, the Federal Reserve has insisted that inflationary pressures are transitory, monetary policy has little to nothing to do with the strength in commodities, and monetary policy needs to remain loose and accomodative for as far as the printing press can see. With the housing market officially taking a double dip and national prices breaking the March, 2009 lows, the Federal Reserve can easily justify standing right where it is…and perhaps doing even more easing in the near future.
The European Central Bank (ECB) was expected to continue its hawkish talk but sorely disappointed markets when ECB President Jean-Claude Trichet backed off a bit in the latest monetary policy statement. Who can blame him with the euro steadily growing in strength against all its major trading partners while several euro-zone countries continue to struggle with sovereign debt issues? For now, the euro’s losses are the dollar’s gains and those gains increase the downward pressure on commodities.
However, throw in the coordinated interest in weakening the Japanese yen and the Bank of England’s low rates in the face of weakening economic data along with creeping inflation, and the continued biases toward monetary accommodation in major industrial powers provide plenty of reasons to stick by commodities. Heck, even central banks continue accumulating gold.
What seems to have changed the most now is sentiment and the structural opportunity to trade silver. From CNBC:
“The CME has hiked silver margin requirements five times this month. The moves helped push silver down from within $1 of its highest price ever. Selling intensified this week after the Wall Street Journal reported that big investors like George Soros were taking profits in the metal. Yesterday, it was revealed that Carlos Slim, the richest person in the world, had begun to sell the metal.”
As a result, silver has dropped like a collapsing bubble, and the liquidation underway is likely to spread to other asset classes.
Silver’s sudden 30% drop from its recent highs has not been matched by gold. Since Friday’s highs, gold is down “just” 7%. Thus, the gold/silver ratio has rebounded sharply in gold’s favor this week. Silver’s out-performance to-date has been sharp and persistent ever since its run-up began in earnest last August. That move seems over for now.
For over two years, silver miners like Pan American Silver (PAAS) had more or less kept pace with silver’s gyrations, including the sharp rally from last summer. That relationship broke down abruptly in 2011. While PAAS has struggled lately because of geo-political risks, it appears the PAAS-to-silver ratio is finally going to revert to the mean.
In other words, while silver has experienced an extremely sharp pullback and is equally extreme in its oversold conditions, the adjustment in its price is likely far from over. Silver has exhibited parabolic-like moves at least twice before April’s run to $50. In November, I thought higher margin requirements at that time would create an extended cooling off period from what I thought was a near-parabolic move. In less than a month, silver ripped higher to fresh highs in another near-parabolic run before finally cooling off just a bit. So, I can sympathize with anyone who figured that April’s run would not generate much of a pullback even in the face of even more tightening of margin requirements. However, this pullback is a buying opportunity that will be much more clear in the many months ahead.
The market seems to be slowly grinding itself into a huge fit over the risks of imminent economic weakness. Given the Federal Reserve will likely respond by printing more money – the first two rounds of printing clearly not being enough – I will continue to bet on the side of commodities, including silver and gold. Only some fundamental change in the globe’s demand profile and/or monetary policy will get me rethinking my bias to accumulate on weakness.
I found quite instructive the following quote from Jeremy Grantham’s April newsletter titled “Time to Wake Up: Days of Abundant Resources and Falling Prices Are Over Forever” (emphasis mine):
“How does an investor today handle the creative tension between brilliant long-term prospects and very high short-term risks? The frustrating but very accurate answer is: with great difficulty. For me personally it will be a great time to practice my new specialty of regret minimization. My foundation, for example, is taking a small position (say, one-quarter of my eventual target) in “stuff in the ground” and resource efficiency. Given my growing confidence in the idea of resource limitation over the last four years, if commodities were to keep going up, never to fall back, and I owned none of them, then I would have to throw myself under a bus. If prices continue to run away, then my small position will be a solace and I would then try to focus on the more reasonably priced – “left behind” – commodities. If on the other hand, more likely, they come down a lot, perhaps a lot lot, then I will grit my teeth and triple or quadruple my stake and look to own them forever. So, that’s the story.”
In the middle of a stampede, running with the herd feels more natural than building a corral. But for folks who still believe in the longer-term story, you should start putting some posts and stakes in the ground somewhere (while dutifully respecting the risks of getting trampled!)
I am keeping Grantham’s words close by the screen. I began re-establishing positions in PAAS last week and SLV this week (trades tweeted @DrDuru with the #120trade hashtag). I hope to have more commentary in the future on Grantham’s massive review of 100 years of commodity prices and his forecasts for short-term weakness and long-term strength. In the meantime, I highly recommend you read it for yourself.
Be careful out there!
Full disclosure: long PAAS, SLV, GLD, EUR/USD, USD/JPY, AUD/JPY