A good rule of thumb would be "Volatility at the top, drop like a rock." If you study the price of anything in general, periods of price volatility/instability/greater fluctuations tend to dictate periods of change instead of opportunities to buy the dip.
Over the last two years, everyone ran from the dollar and decided that investing in commodities was a great way to protect yourself from Ben's printing machine. Oil is now an asset class. Regarding the recent surplus in demand for commodities, it's mostly speculative, and since the beginning of this year has really blown bubbles into various commodities like silver. Considering that the top just blew off less than a month ago and we've only retraced a month or two of gains, I have reason to at least strongly consider that we have not yet seen the lowest prices for silver in 2011.
As a potential buyer, the first time around, a volatile swing lower strikes me as a buyiing opportunity. As you start counting the swings, however, I increase my hesitancy to buy. I start to wonder how on earth this alleged store of value can swing in value so wildly? After all, aren't precious metals supposed to protect me from Helicopter Ben's money printing machine?
The Contagion of Lower Prices
As I look into the eyes of the market, I am seeing all sorts of warning signs. Copper is weaker; China is considering lower interest rates; margin is attractive again; unemployment is relatively high; home prices are falling. All of this makes it look like the rise of commodity prices is not likely coming from consumption, because that appears to be falling. Demand appears to be far outpacing consumption.
Assuming that this cannot last, prices that are soaring to the sky will have to turn around and be brought back down to earth. As this happens, industrial related stocks will suffer too. With a lot of this demand being speculative, as trends reverse, speculative demand to buy will rapidly turn to speculative selling pressure and liquidations.
China Has Its Own Problems
China has stepped in and thrown a wrench into anyone's game plan that this was going to be a straight drop to the bottom. That said, I think that China has more problems than meets the eye. A lot of loans in China are asset-based. A lot of homes are priced at premiums to which they are able to rent. There are a lot of structural reasons for ridiculously overvalued prices in real estate in China.
My friend in Shanghai pays $1000 a month for rent on a place that is valued at around $700,000. Apparently that's the norm. Is China going to continue to be able to fund perpetually higher real estate and commodity prices? Do real estate prices only go up?
To answer that question, perhaps I should follow with another question. How much can you convince someone to pay for a property that rents at $1000 a month and is surrounded by vacant properties? Did I mention that a lot of bank financing is collateralized by hard assets in China? Isn't it ironic that they borrow against hard assets to invest in other hard assets? Is this sustainable? It wasn't the last go-round, 50 years ago.
Silver, Gold and Volatility
Precious metals are great when you're experiencing true inflation. That said, I think what we are seeing isn't inflation as much as we are just seeing a government-sponsored run to invest in commodities while the economy stagnates, the volume of loans decreases, and unemployment rises. One thing that I can continue to count on going forward is higher volatility. Instead of trying to hedge against future uncertainty by purchasing silver and gold, I'd consider buying call options on the VIX on dips, selling the rips, and doing the reverse on gold and silver.
Disclosure: I am long ZSL.