Why the Next Silver Correction Could Be Nastier

Jul.20.11 | About: iShares Silver (SLV)

Remember last silver correction, three months ago?

In just a few days, the “poor man’s gold” lost close to 35 percent of its value—catching by surprise all those who believe that the heavy metal can defy gravity in the land of near free money.

In recent days, the metal has recovered nicely, however. The iShares Silver Trust (NYSEARCA:SLV) has rallied from low 30s to high 30s—drawing the enthusiasm of traders who believe that the correction in the price of the metal was just a pause in a secular rally. But do fundamentals support such a belief?

We don’t think so. As we wrote in a previous piece, silver is a good short—better than gold because silver has appreciated much faster than gold in the last two years, an anomaly, as gold has traditionally appreciating faster than the silver; and the fact that silver is more sensitive to a weakening economy that may be in the cards—and recent evidence confirms that such a weakening is already a reality.

Here, I want to add another factor that may cause a sharp correction to both silver and gold: The prospect of some sort of resolution on the European and US debt. In fact, Europeans seem to already have a plan dealing with the heavy debt burden of Greece, to contain any contagion scenario. And Americans are moving forward with their own plan.

In the meantime, most of Europe is already under austerity, and chances are that America will embark on its own austerity plan. This means that, at least in the short and the medium term, economic growth will slow further in both Europe and the US. And the sluggish Japanese economic growth, and the de-acceleration of the Chinese economy, and you certainly have a bearish growth for silver—it may reach 25 before it reaches 50!

Disclosure: I am short SLV.