Home > Silver Investors: What Goes Up, Must Come Down…Eventually (SLV, AGQ, ZSL, DBS, PSLV, GLD, IAU, USO)
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Silver Investors: What Goes Up, Must Come Down…Eventually (SLV, AGQ, ZSL, DBS, PSLV, GLD, IAU, USO)

April 23rd, 2011

If you think the crude oil market has gone totally out of control in the past month or so, observe the Silver market, which has basically gone parabolic in the week of April 17, going from $41.75 on April 15th to $46.69 on April 21st–a 12% move in 5 trading days, topping off the move with a 5% move on Thursday (See Chart). 

As Silver is a thinly traded market, one thing the CME could do is to raise margin requirements for Silver speculators; otherwise risk is setting up the silver market for an record-setting crash, which could impact many other markets in the process of correcting, especially other commodities like Gold and Crude Oil.


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A Silver Contagion

We are not talking about a 5% correction setting up at these levels for silver, we are talking in terms of a 20% down day that poses a contagion effect to markets in general.

The reason the contagion risk in the Silver market is that while Gold is going up half a percent to one percent, Silver is logging in 3.5% days routinely (See Chart below). Well, what goes up, must come down… eventually.  So, when this market breaks, it is going to break hard to the order of 10% easily. 

That kind of market selling will not occur in a vacuum, especially since commodities have been trending up as a group, i.e., the same hedge funds and banks are trading all the risk-on commodities as well, like Gold, Copper, Crude Oil, Wheat, etc.

In other words, if Silver gets a 10% down day, which it almost will for sure, and if it isn`t cooled off considerably with proper margin requirements instituted by the CME, then, the rest of the commodities will be forced to overshoot to the downside as well.

ETF Trading & Portfolio Rebalancing

There are a couple of reasons for this.  With the advent of commodity funds, silver is part of the basket of commodities in the funds. Also, because traders will not want to fight the tape, shorts will come in and take advantage of the selloff in Silver to push other commodities down through ETF trading vehicles.

Moreover, the same banks and hedge funds trading silver are also involved in the major commodity groups as well, and they will be liquidating other positions to keep their portfolios balanced with regard to risk. So expect a lot of portfolio rebalancing to take place if the Silver market drops 10% in a day across many hedge funds.

Price & Margin Out of Balance

The CME routinely sets margins based upon contract prices. So, if Silver goes up $10 more in price, then the ratio of margin to price goes down. In order to realign margins with the higher price, CME would raise the margins.

The reason this becomes a problem is that if price gets too far out of balance with margin requirements, the risk goes up, because traders will not be properly sized with regard to risk for a potential correction, and many trading accounts could be devastated due to overleverage.

Black Silver Swan

In addition, if Silver speculators are all heavily leaning towards one direction as the action of recent silver price movement suggests, then, there is an increased risk of a major market dislocation, thus creating a ‘black silver swan’ day. That’s exactly the kind of event that exchanges try to prevent from occurring, as it is extremely unhealthy for markets, and bad for business.

It is obvious to anyone observing the Silver market that it is overheated to the Nth power.  The longer CME ignores the problem, the worse the consequences will be down the line. When all the other risk-on commodity trades are putting in 1% days, and Silver is putting in 5% days, then you know the longer this goes on, the higher probability that this trade and market could end very badly.

Flash Crash 2.0?  

As the very real possibility of a 20% two-day correction is moving towards becoming a very real probability, it could bring down a lot of other markets in the process. Remember, we had the flash crash around this time last year?  Well, if the Silver market isn`t cooled off, it could potentially be one of the catalysts for another broad flash crash this year.

Raise Margin Requirements by 30%

The easiest way for the CME to lessen the probability of an epic crash in the Silver market, and the subsequent public and regulatory inquisitions, would be to raise margin requirements by at least 30%, as the starting point.  

Actually, the CME could be a little late based upon the manner in which silver speculation has gone bizzerk, especially over the last trading week–the market has simply become parabolic. The CME could have raised margin requirements once Silver broke $40 an ounce, and without a doubt they should have raised margin requirements on the 14th of April, before this latest 12% weekly move.

The longer the CME fails to address the problems in the Silver market to rein in excessive speculation, the more risk there is of an extreme market crash.  Just as I said before–”The white metal appears overbought and could be heading towards a bubble stage,” and without QE2, that bubble would have formed and burst by now.

Silver A Screaming Short   

With gold/silver ration setting new 28-year low record almost everyday in April, it looks like the necessary elements are already set in motion for another horrid crash and burn contagion scenario–but this time originating from Silver–due to the interconnected nature and electronic evolution of modern day markets.  Any intervention effort by that time would most likely be futile in the face of a multi-market algo contagion.

Related ETFs:  U.S. Oil Fund (NYE:USO), SPDR Gold Trust (NYSE:GLD), iShares Silver Trust (NYSE:SLV), Sprott Physical Silver Trust (NYSE:PSLV), ProShares Ultra Silver (NYSE:AGQ), PowerShares DB Silver (NYSE:DBS), ProShares UltraShort Silver (NYSE:ZSL), iShares Gold Trust (NYSE:IAU).

Written By Dian L. Chu, Chartered Economist From EconMatters

About Dian L. Chu, CPSM, C.P.M., Chartered Economist:  I’m a market analyst, economist, writer and editor of EconMatters blog.  The theory of quantum mechanics and Einstein’s theory of relativity (E=mc2) have taught us that matter (yin) and energy (yang) are inter-related and interdependent. This interconnectness of all things is the essense of the concept “yin-yang”, and Einstein’s fundamental equation: matter equals energy. The same theories may be applied to equities and commodity markets. All things within the markets and macro-economy undergo constant change and transformation, and everything is interconnected. That’s why here at EconMatters, we focus on identifying the fundamental theories of cause and effect in the markets to help you achieve a great continuum of portfolio yin-yang equilibrium.



NYSE:AGQ, NYSE:DBS, NYSE:GLD, NYSE:IAU, NYSE:PSLV, NYSE:USO, NYSE:ZSL


 

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  1. Diamond
    May 6th, 2011 at 14:49 | #1

    You were bang on the target about 20% downside for 2/3 days.
    Nice work !

  2. Ken Danagger
    April 28th, 2011 at 19:13 | #2

    Amazing how all these hack analysts claim that Silver is in a bubble.

    They give no thought as to the reason WHY the “price” keeps going up.

    Silver is one of the most reflective metallic elements (Gold is another). In addition to being the preferred metal for reflecting light in the visible spectrum, Silver is also highly reflective of something else… The value of the fiat currency that it is priced in.

    When the central banks stop creating trillions out of thin air and pushing in on stupid politicians like drug dealers and crack addicts, then the nominal fiat paper price of precious metals might drop.

    Despite the still dominating lie of Keynesian economics, it’s all about allowing the market to find a free equilibrium. Printing vast sums of fiat paper to prop up reckless bankers and corporations is stealing from the rest of us, and is also a recipe for a much larger disaster.

    We need a controlled burn to clear out all of the reckless failures and toxic debt. If this mess isn’t liquidated, pressures will continue to mount and an enormous wildfire will be inevitable. Market forces can only be opposed for so long. In the end they always win – ALWAYS. History has proven this over and over again.

    Of course the Keynesian central planners have deluded themselves into believing that this time is DIFFERENT. This is exactly the same path that has been traveled before – and it always meets the same ugly end.

    “Insanity is doing the same thing over and over and expecting a different result.” – Albert Einstien

    “Those who fail to learn the lessons of history are doomed to repeat them.” – George Santayana (and many others since)

  3. Jimmy Five
    April 25th, 2011 at 14:12 | #3

    “In other words, if Silver gets a 10% down day, which it almost will for sure”
    So, you think it will or not will, almost for sure crash?
    Joke aside, I believe the article, as mentioned by Ed and Jerome, lacks other important factors to take into consideration. Check out some YouTube videos with Jim Rogers, Marc Faber, and some others. They have a better explanation.

  4. April 25th, 2011 at 13:18 | #4

    I’ve been reading these stupid articles since SILVER was $8. Readers have to understand bubbles. The tulip bubble went up 16,000 percent before the collapse. GOLD has gone up 450%, Silver around 600%. Silver has gone up 11 fold during the 80 bubble. It has gone up only 6 since this one initially started in 2000. Learn about the greatest 50 bubbles of all time, you will hold onto all the SILVER you can. WE HAVE A LOOOOONG way to go, do not let these articles persuade you to sell.

  5. April 25th, 2011 at 10:32 | #5

    But how bad would a 20% down day be? That’d still leave silver over $35 per ounce. We were sitting around with silver $16-19 per ounce for a long time, and that’s after a longer time at $4-10. I think her point is not that silver is done for, but that there could be some huge cliff drops on the way to new highs. Maybe just buy a little ZSL instead of more silver while it’s hitting new highs. That said, while I wrote this AGQ went 1.5% red to 1.9% green.

  6. Fearless Longhorn
    April 25th, 2011 at 09:50 | #6

    GLD is up today! The silver ETF’s will remain on the uptrend as long as the gold ETF’s are on the uptrend until QE2 is over in June.

  7. jason
    April 24th, 2011 at 11:56 | #7

    canadian loonies???????????wtf@Ed Summers

  8. Ed Summers
    April 24th, 2011 at 02:33 | #8

    Neither does she take into account one of the most important facts that exist at this moment in time. Fear. In the U.S. we fear what is not only happening to the world, but we fear that all of our leaders have no idea of what is happening and are unable to grasp the depth of our economic problems. I’ll stick to buying Silver and Gold and Canadian loonies until I feel the fear begin to go away.

  9. Jerome Equichano
    April 23rd, 2011 at 18:11 | #9

    The article’s assertion that silver price will come down is based on the statistics alone. Factors like politics, inflation, etc. are not discussed. Ms. Chu keeps saying that the silver price will drop a significant amount and that it is due to the silver and gold ratio needing to be realigned. Silver is playing an increasingly important role as technology progresses. It is not necessarily true that the silver and gold ratio MUST be a certain number. Look at the inflation adjusted price of silver. This is not near the 1970s level yet.

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