Which fear is stronger for investors? Is it the fear of missing out on future upside? Or is the fear of losing more money more dominant?
When it comes to silver, it looks like we are in a short period of time where the dominant fear is of the shorts failing to lock in sizable gains. When that fear subsides, and if you let fear be your guide, the dynamics all point to lower prices. We've only erased two months of gains.
Normally, erasing two months of gains could be considered a healthy pullback. I urge you to compare the recent price action with the healthy pullback around January of this year. It's not even comparable unless you honestly believe silver's latest trajectory is going to a fair value, which would put silver annualizing 25%+ returns going forward.
What's more likely is that the prevalence of ways to invest in commodities through ETFs has inspired a bubble that is now correcting (click to enlarge images):
What I've Done:
Recently, I’ve been making a lot of my silver decisions based on a combination of price action and headlines. I went short when we stopped setting new highs, headlines were projecting much higher silver prices, and the perpetual bull community seemed to start to really believe that there were shortages.
It’s amazing what you can prove if you purposely use a small, biased sample size. I covered my shorts when the price started to go against me, Billionaires like Soros and (the richest man in the world) Carlos Slim were announced to have been sellers of silver and the exchanges were hiking the margin requirements to play the game of silver.
Bulls Grasping at Straws:
Lately, however, I have read arguments from the bull camp which make me think that we are headed lower, including that Carlos Slim’s selling in recent weeks is a bullish indicator. I ask you this: If the richest person in the world is selling at around the all time high of anything and the price plummets 20%+, how do you chalk this up as bullish?
I've Lost Before Ignoring Fear:
Look, I’ve been on the losing end far too often. It appears to me that the probabilities going forward are still stacked against the bulls. To derive this conclusion, you have to be transparent with yourself. The strongest motivator in the world is fear. People tend to buy en masse when the overwhelming fear is the fear of missing out. People tend to sell when the overwhelming fear is that more losses are on the way. Empirically speaking, this checks out since most people actually lose money in the stock market.
Still Unpriced Systemic Risk:
The way that I’m thinking about this latest price action is that a whole lot of people are still long silver from higher prices. These people are breathing a sigh of relief right now. Factor this in with my belief that oil prices must come down in the short term, as current prices are leading to excess supply and hurting end-user demand. As oil prices continue to fall, that should put pressure on precious metals.
Not only that, but I believe that the dollar can keep rallying in the near term. And then you have a situation where, globally, homes are overvalued, as I believe that you can only price homes as a function of your ability to rent them out at a given rate of rent. So, with these factors --- take a step back and look at the market.
No Fundamental Shift:
I still think that buying silver at current prices is dangerous. If prices go up $1, I think that people will be relatively less afraid of missing out than they would be afraid of future losses if prices go down $1. I see it as a game of fear. Are the shorts in denial right now? It doesn’t appear to be the case. They appear to be covering their shorts. When things fall, you almost never have a situation where they fall at this trajectory, bounce, and go higher. We would need to see a fundamental shift for that to happen and I haven’t seen any fundamental shift that would support much higher silver prices in the last 4 days. The announcement of QE3 is the type of fundamental shift that I’d expect to bolster silver prices.
What Bottoms Look Like:
From the perspective of fear, the willingness of investors to purchase silver goes down as prices go down. Note also that the ability of a fixed amount of money to buy a percentage of the daily trading volume of silver goes up as prices go down. In my opinion, bottoms tend to happen with headlines like, “Traders Make Millions Shorting Silver,” “Trade of 2011: Short Silver,” and “Is Silver a Precious Metal?”
More Skeptical Buyers:
I’m just saying that after recent price action, the average person is surely more skeptical of silver. Try to convince anyone that they should be a buyer at $40 --- you cannot unless they have already convinced themselves that the world is ending. And so, my mentality defaults to “dead cat bounce.” I currently have no position but am looking to enter short again as we touch new lows. Bouncing off the lows is less likely than crashing through them based on the fear principle.
Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in ZSL over the next 72 hours.