On April 14, I suggested that the price of silver was long overdue for a correction.
The vitriol instantly hit our inbox …
"Rubbish" … "Chucklehead" … "Nice try, buddy" … "We're in a whole new world.” (The latter of which sounds like a euphemism for "it's going to be different this time," which is never the case.)
I've learned to treat such negative feedback as a confirmatory signal. Every other time I've issued a controversial, contrarian call – whether it's on the U.S. dollar, oil prices, real estate, etc. – my inbox was flooded with incensed and defiant readers.
Until they found out I was right.
So go ahead and ignore my prediction about silver prices being overdue for a correction. Blind faith in an asset is precisely the factor that makes massive corrections possible.
Then, as the price starts to stumble, instead of selling, denial kicks in. Pain and heavy losses quickly follow. And I'm convinced that many investors are about to learn this truth the hard way.
Why? Because silver prices just started to stumble. And all signs point to the decline continuing…
The Silver Fever "Breaks"
Over the past year, interest in silver has hit fever-pitch levels. How else do you categorize a 150% increase since last August and a 60% jump in 2011 alone?
The most recent trading volume data smacks of rampant speculation, too.
The Wall Street Journal reports that 319,205 silver futures contracts traded hands on April 25. That's 50% higher than the previous daily record last fall. And for the overall month of April, average daily trading volume roughly tripled.
Hmm … such volume spikes couldn't possibly be a sign of speculation, could they?
Well, as you know, no asset shoots higher forever without pulling back along the way. And silver is no different.
On Monday, silver prices hit the skids, dropping 12%. And the metal has continued to fall all week.
The main culprit? Exchange operator CME Group (CME). It's jacked up the margin requirements for trading silver futures three times over the past week. And there's only one way to interpret such moves …
It's Time to Pay More to Play
When an exchange operator hikes margin requirements by 38% in a week, it's not because it wants to encourage more trading. On the contrary … it wants to discourage speculation.
Or as Bernard Sin, the head of currency and metal trading at MKS Finance SA, told Bloomberg News, "The exchange is trying to calm the market down. It's been overheating.”
The quickest way to do so, of course, is to make investors put more skin in the game. And that's precisely what's happening.
A year ago, the minimum amount of cash required to trade a silver futures contract stood at $4,250. After the latest margin hike, it stands at $16,200.
Yep … I'd say a roughly four-fold increase in the ante is a deterrent.
And I'm certain that the next round of trading data is going to show that the increases have forced smaller investors to liquidate their positions. It might have convinced savvy investors that it's time to lighten up, too.
After all, when the exchange operator starts getting worried about speculation, shouldn't we?
"Denial Ain't Just a River in Egypt"
Of course, diehard silver bulls are bound to dismiss the new margin requirements as merely a speed bump. They'll point out that past price hikes led to short-term sell offs, so it's bound to happen again.
Then they'll cue up their lines about how it's an institutional conspiracy to manipulate prices, plus the soaring industrial demand, in order to try to convince us that silver can only head higher from here.
Sure, formal lawsuits against JP Morgan Chase (JPM) and HSBC Holdings (HBC) lend legitimacy to conspiracy theories. But that's what makes people buy into conspiracy theories – just enough evidence to suggest it's possible, but never enough to prove it happened.
As for the industrial demand argument, I pointed out last time that even the most robust increase can't fill the void if the speculative demand suddenly disappears. Remember, investment demand jumped 41% last year, nearly doubling the growth in industrial demand.
So with supplies increasing, basic economics should ultimately prevail. In other words, look out below!
And let's be fair … a massive and sudden price drop is exactly what we should expect when it comes to trading silver.
Fact: Silver Is Notoriously Volatile
Analysis firm, CPM Group New York, said it best this week: "No asset in history has risen so sharply so rapidly and retained most of its price appreciation. Silver has no immunity to the laws of the markets.”
History bears it out, too.
After rising to a record $50.35 in January 1980, silver prices plummeted 78% in four months. And during the financial crisis, silver lost half of its value in the blink of an eye.
Heck, even Wall Street's blue bloods aren't ignorant to the potential for a silver haircut…
- "Silver is due for a correction … as we're approaching the seasonal period where silver reaches an interim high,” says CIBC in its latest report.
- Swedish bank SEB said it expects the violent corrections lower to continue.
- And from the "No Surprise Here" files, Switzerland's UBS is – you guessed it – "neutral" on the outlook for silver in the medium term.
Get Ready for $30 Silver … and Invest in These Stocks
Bottom line: Silver is prone to nasty corrections. And while it's premature to say, "I told you so," the price action certainly suggests we're headed for another one.
In fact, the price could drop as low as $30 per ounce.
If I get bombarded with nastygrams again, I'll know I'm on the right track – and that the price might fall even more.
If you insist on ignoring my prediction, at least be smart about investing in silver right now. How?
By opting for silver miners, instead of silver bullion.
While bullion has blasted higher – up 55% this year, based on the iShares Silver Trust ETF (SLV) – silver miners have lagged significantly. Case in point: the Global X Silver Miners ETF (SIL) is only up 5% over the same period.
If silver prices are indeed headed higher over the long term, such a performance disconnect should neither exist, nor last.
Then again, maybe investors in silver miners are sending us a signal – that prices are headed even lower.
Time will tell, of course. But whatever you do, ignore the recent developments at your peril and proceed with caution.