Silver Is in Blow-off Phase - Top Could Be Near

Includes: GLD, IAU, SLV
by: John Tobey, CFA

Silver has entered a third growth phase, with the price increasing at about a 2,000% annual rate. Clearly, those gains are unsustainable. The question is, at what point will the trend reverse?

A bubble picture
This graph () shows how silver’s price rise is in a third, hyperactive phase.
Silver price rise phases
Phase 1 had it paired with gold at a rate of about 25% per year. In Phase 2, beginning around September last year, silver took off, rising at around a 200% annual rate. In phase 3, silver has risen from $37 to $48 in one month, equivalent to an annual return of about 2,000%.
Silver’s difference from gold
The Wall Street Journal’s No Silver Lining Left for Users of the Metal” discusses silver’s key difference from gold: Industrial use. The price rise has led to companies attempting to lock up supplies, thereby causing the price to rise further.

Silver investors are smiling about this year's rally in the price of the precious metal, now closing in on an all-time high. But silver's surge is hurting major users and even a few miners, including some blindsided by the relentless climb.

Nearly 75% of the world's silver supply is used to make film, jewelry, mirrors, batteries, solar panels and other products. While companies have scrambled to find cheaper substitutes, reduce their silver use or lock in hedges against future price increases, the moves aren't enough to offset the pain.

That explains a lot of why Phase 2 took place, but what about this latest burst of speed?
The final stage of bubbles and blow-offs
When an uptrend gets carried away, fundamental valuations become meaningless. Instead, price action itself, becomes the driver. Adding to the push are the short sellers who toss in the towel along with the latecomers attracted by the apparently easy, quick gains.
Large, upward price gaps can occur as new demand overtakes available supply. At this point, there is only one “cure” for the runaway price: New demand drops off. With happy, but nervous, holders watching every price change, any falloff in the uptrend can lead to a profit-taking dip. And, if that dip doesn’t bring in buyers, the selling can increase, creating a further drop. Gaps down then can occur, causing some to hold on for a bounce back, but at some point the uptrend is clearly broken.
Example: Gold’s blow-off in 1980
Amid gaps up and gaps down, the gold bubble burst. The news didn’t cause it - enthusiastic gold articles and terrible economic reports continued throughout this period. Demand simply dried up and that meant holders became sellers. Click to enlarge:
Gold 1980 bubble
Studying previous blow-offs reveals a similar pattern, although the percentage run-up can vary. What can be observed is a dramatic gain in a very short period of time. In 1980, gold’s final rise was about 100% in two months.
What about gold?
In three previous articles (see list at the end of this write-up), I described gold’s situation. Although gold has had an extended, popular run-up, there is not yet a blow-off pattern. Compared to silver, its steady uptrend looks restrained.
However, not all uptrends end in blow-offs. Overvaluation usually defeats an overdone price rise. Gold continues to be higher risk because of its high price, but it doesn’t have silver’s added blow-off danger.
So… silver looks to be in a blow-off stage. Could it go higher? Yes. However, it’s just a matter of time before buying at ever-higher prices dries up. Then, nervous holders can create the next phase: Rapid downtrend.

Three previous articles about gold:

Using History to Determine Gold's Intrinsic Value” (April 8)

Disclosure: No long or short positions in gold or silver securities