Silver is booming—but it could be entering bubble territory now
Rahul Sonthalia 26 April 2011

Silver has risen to an all-time high, immediate delivery prices are up 5.4% at $49.79/ounce, surpassing the previous high of $49.45 in 1980. But as global analysts predict, this rally may not sustain—and a correction could be on the cards

There is a very interesting theory in financial markets called as 'The Bigger Fool' theory. It says that there are times when the only reason 'X' buys an asset class is because X believes that there is a fool (Y) who is a bigger fool than X, who will buy the same asset from X at a price which is higher than what X has already paid for.

The second person buying the asset also feels the same, so will be the case with the third person and so on... and the price of the asset keeps increasing. However, when the asset reaches its peak price, the fool (the biggest one of them all) holding the asset can no longer find a fool bigger than himself. So he eventually sells to someone who is slightly wiser than himself-and thus the price eventually crashes, leaving the ones who bought at the peak price depressed for ever.

At current levels, silver is one of the biggest examples of this bigger fool theory in live action. Over the past one year, the price of silver, a (relatively) poor cousin of gold, has glittered way beyond anyone's expectation, rising up by over 145%. It has become one of the best performing asset classes in the world, beating every possible resistance level which market pundits could chart.

The so called commodity 'experts' appear on TV and give their short/long term target for silver, the same way they predicted the target for crude oil when it was $140 in mid-2008 (targets were $200 by December 2008).

This also reminds me of the 'target levels' for the Sensex which were predicted in January 2008. The index was expected to touch 25,000 by the year-end.

We all know what happened to these targets. There are fundamental reasons that lead to a rise in silver prices from Rs20,000 levels to around Rs40,000, but after that it's probably the 'greater fool' theory at work.

People have started speculating hugely in the futures market assuming that once JP Morgan comes to unwind its over 3.3 billion ounce short position in silver, it would lead to a short-covering rally. JP Morgan's position is over 1/3rd of the world's known silver deposits (or four times the annual mined supply of silver in the world).

At a price of Rs71,800/kg, there are many who are cursing themselves for not entering the great silver bull run at Rs40,000, Rs50,000 or even at Rs65,000 and are planning to enter now so that they can get rid of the sorry feeling that they are now experiencing for having missed out on this amazing money-minting opportunity.

This sorry feeling which results in individuals chasing any asset class for not wanting to miss the bus is precisely what creates a bubble. It's the same feeling which the masses had when the Sensex was at 21,000 in January 2008, or when crude was at $140/barrel in July 2008 or during the period of the US housing bubble or the dotcom bubble... or even the tulip bubble which occurred in Holland some 370 years back.

So I strongly believe that the upside potential for silver is limited. It can go to Rs75,000 or even Rs80,000/kg. However at that level, I am sure that no one will sell, hoping for a further rise and will eventually end up holding the contracts of the metal at some beaten-down levels.

Retail investors should avoid chasing silver, especially in the futures market, since a correction in prices is long overdue. Top commodity investor Jim Rogers holds the view that a correction in silver is required, for it to sustain on its long-term trajectory. He has been quoted as saying: "I am worried about silver. If silver continues to go up like it has been over the past 2 or 3 weeks, yes, then it would get to triple digits this year.  And then we'll have to worry.  It's not parabolic yet.  I hope something stops it going up in the foreseeable future and we have a correction. There's never one in history that hasn't popped.''

The biggest reason for the crash in the US housing bubble, or the crude bubble or the dotcom bubble or any other financial bubble in history is the realisation that prices would rise forever and can never correct. Once this realisation sets in (as is happening in silver) one can believe that the bubble is at its peak and a fall is inevitable.

Comments
Vikas
1 decade ago
Rahul
Would love to know why you think the JP Morgan unwinding will not drive the prices further?
Also, China has clearly stated part of investments going forward into precious metals. Even a few billion USD from China can totally shake the market. Why would that not be bullish?
The USD, the world's reserve currency is down substantially (just look at the DSX). Why would that not be bullish?
And, most fiat currencies of the world are facing devaluation 'in-situ' - by inflation. Why would that not be bullish for silver?
I think the article misses some very big points, and you have resorted to 'hand-waiving' without substantial facts about the extent of these issues.
Rahul Sonthalia
Replied to Vikas comment 1 decade ago
Silver, Selling freeze in domestic spot markets and down by over 10% in international markets. All the points you mention Vikas are correct, however they do not justify a rise of over 150% in 8 months.. Fundamentals should result in gradual substantial rise, rather than a big one time rise... The fate of Crude, Housing, Dotcom, Sensex @ 21k, ... teach so many lessons.... Silver will also become a case study in future...

Fundamentas like China Buying, dollar index falling, etc. are there... However, they support gold more than Silver
prateek
1 decade ago
bang on..silver prices really look unsustainable at this level. 2 much noise about silver doin d rounds..precise article.
Ajeya Sadashivaiah
1 decade ago
Rahul, in 1980 the bull run of Silver was engineered by "Hunt Brothers". Silver dropped like pack of cards in 1980 itself.
Finally "Hunt Brothers" filed for bankruptcy. This time I don't think any one engineering the silver bull market.
But yes silver has went into to the "Bigger fools theory", it has to fall.
Recently I think "Union bank of India" started selling silver bars, when more banks enter selling silver bars then it is the time to sell silver. That opportunity will come soon, may be this year. One more thing, when silver was trading at 6-7 thousand per Kg I think no bank use to sell silver bars.
Pankaaj Maalde
1 decade ago
good informative article on silver. this will help readers to stay away from this.
Alfredo Coronado
1 decade ago
Silver is still cheap. There are 10 ounces of silver to 1 gold, and almost 90% is consumed. Already been extracted from the mines to 80%. Silver has an intrinsic value greater than gold. And U.S. finance is terrible, impressive:
K A PRASANNA
1 decade ago
Silver is already in bubble territory. It is driven by dollar weakness and supply concerns. Expect major reverse trend soon. FIRST CHOICE IPO.
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