Monday, May 16, 2011

What's behind the Silver Bubble?

As this Kitco chart illustrates, the price of silver was lagging the increase in gold prices, until the last few months, when it went ballistic.  By the way, the Kitco site seems to have the best charts and data for minerals - not that I recommend investing in minerals. 

Small investors have been screwed by silver, time and time again.  Unlike gold, silver has fewer industrial uses - it corrodes easily and thus makes for a poor electrical conductor.  It is useful in film processing, but film is largely a thing of the past.  As a result, silver tends to be hyped by people even more than gold, and bought by the hoi polloi more-so than Gold.  And the small investor usually gets creamed in these silver bubbles, as was the case last week.

Why do these speculative bubbles burst?  The fundamental flaw in both the silver and gold run-ups is the something-for-nothing mentality.  People like to believe that you can buy something - a stock, a house, a mineral - and it will magically go up in value and make them rich.

Sometimes this happens, but more often not.

And for every person who makes money this way, there is usually at least one or two who lose an equivalent amount of money.

Buying and selling commodities or betting on stock prices (or house prices) is not creating wealth, but rather, rearranging it, like in a Casino. Just spending, not making.

So we recently saw the oil bubble burst (and yes, oil is a mineral).  And the silver bubble burst.  And the housing bubble burst.  And yes, we will see the gold bubble burst, too.  And those who got in late will be creamed.   Those who got in early will have a rate of return that is close to inflation only.

Merely buying and selling things, without adding value, is not usually profitable, except in the few rare instances where a few rare individuals can time the market.  And you and I are not those rare individuals.

As the chart above shows, the price of Gold has been leading silver and has done so historically.  In recent years, gold has perhaps leapt out ahead of silver, prompting many of the self-interested metals promoters to hype silver as "the next big thing".

And as the next chart illustrates, since about September 2010, the increases in silver prices leapfrogged gold, as Joe Smalltime got into what he perceived as an "affordable" market.  In a few short months, the price of silver skyrocketed, and then tanked in the last few weeks.

People who bought at the height got creamed.  And the bubble burst in a relatively short period of time, too.

What was behind the silver bubble?  Hype, pure and simple.  The odious people on television that tout minerals as the investment for the everyman, while at the same time owning interests in minerals companies, are the ones to blame.  They scared people into believing that the end of the world was nigh, and moreover that minerals were their only safe harbor.

We were treated to scare stores - the USA will default on its debt!  Social Security will become bankrupt!  We are all going to DIE!

Well, only the last statement has any truth to it.  Short term financial trends are rarely sustainable.  The rapid rise in unemployment benefits spending has put a dent in our budget.  But it likely will not be a permanent trend, for the simple reason that more people will go back to work, over time, and eventually, unemployment benefits will be cut off, forcing many people to seek out jobs they are refusing at the present time.

And the Social Security crises will be solved the same way they have solved it every time before - by raising the cutoff so that more money comes in - and no one will call it a tax increase, of course.  And the baby boomers, being overweight and in bad health, will die off sooner than their parents, which will relieve the system of much stress.

We are all going to die, that is true.

The question remains, will the Gold bubble burst next?  All I can say, is stay tuned.  With every piece of good economic news, the idea that buying gold is the answer will take a hit.  And once people stop buying, the price will go down, which will encourage more to sell, and the snowball effect will take over in short order.

At $450 an ounce production cost, $1500 an ounce market prices simply are not sustainable.

When supply exceeds demand, the market will adjust.  We saw this in silver, we recently saw this in oil.  I think we will see this in gold.