Investing is not easy during the best of times. If you’ve read my writings or are a member of my trading service “The Trojan Secrets“, you know that I am a strong believer that the markets are rigged…and not in your favor. Two weeks ago I recommended my readers sell out of a precious metals stock that we owned for a quick trade. The metals markets looked frothy and Silver looked especially vulnerable.

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That being said, the bigger point is how these markets trade and how bubbles are going to be a part of our lives for a long time to come. In the past two weeks silver has fallen by more than 20%. That’s a huge drop for any commodity in that period of time. There may be more to come. If you think that the rise in gold has been meteoric, the rise in silver prices has been stratospheric!  Over the past decade, from low to high, silver had risen by a factor of 15 times, compared to a rise in gold by a factor of just five times. There was no justifying factor for this rise other than the fact that silver is viewed as the “poor man’s gold”. But, that’s really all the justification the market needs to create a bubble. In other words, there is NO justification for the rise, just as there was no justification for the Internet bubble, the housing bubble or tulip mania, which occurred in Holland in the 1600s.

Manias and bubbles are created by investor optimism and professional hype. Who on earth in their right mind would pay 1,000 time earnings or book value for an investment? Well, many people did in 1999. Who would pay $1,000 per square foot for a second tier condo overlooking nothing in Miami? Well, people were falling all over themselves to do it in 2006. But these actions could not have occurred without a source to finance or hype them to those levels. That’s where the professionals step in. They’re good at spotting trends, but just as bad at knowing when they have peaked. Still, they serve the purpose of fueling rallies on the way up and then they overreact on the way down, exacerbating the declines. The top tier guys, like Goldman Sachs, figure out how to make money from everyone…on the way up and on the way down.

Let’s take silver for example. On the way up analysts and investors alike were pumping up projections. Stories about short supplies, market manipulation by banks like JP Morgan, buying by fund managers like Soros, Tilson, newsletters hyping and even talk radio served the purpose to rally the troops to buy the metals. Market exchanges did nothing to quell the hype, allowing access to cheap money via low margin requirements for any who wanted to speculate on the metal itself. For commodities it doesn’t take much buying…or selling to cause volatile spikes or crashes. For silver there was an over abundance of buying and froth to send the price to $100 per ounce, not just $50.

So, what exactly happened just before silver reached that magical $50 level. Well, let me digress for a minute. The holy grail for silver was and still is $50 per ounce. Why is that number so important…and so bogus? It’s important because that was the high watermark for the metal set in 1979 when the Hunt brothers tried to corner the market sending the price from $6 per ounce to a high of $48.70. It was no “fundamental” rally, but one that was the result of market manipulation. That in itself is reason enough not to trust the “silver” technicians. What is interesting though is what followed. As silver set highs in 1979, the commodities exchanges increased margin requirements. This means that speculators like the Hunt brothers who were heavily margined, had to come up with a ton of cash to support their holdings. They couldn’t. Silver prices cratered and the Hunts lost hundreds of millions, along with many other investors. The parallel today is that the exchanges raised margin requirements twice in the past
two weeks…and silver crashed as speculators had to come up with more cash or liquidate their holdings. The lesson here is not so much that you shouldn’t invest in margin, but that rallies that are built on leverage and not fundamentals are destined to crash. And, that the government or the exchanges are the wild cards when it comes to investing. Read your brokerage agreement and you’ll realize that the deck is stacked against you.

Is silver’s rally over? Yes, for now. But there is a lot of merit to the argument for buying and holding commodities like silver and gold. The argument is the fundamental crisis faced by the US Dollar. That crisis was not as serious in 1979 as the US was not in the same debt hole as it is today. The question is not whether one should own silver or gold with part of their holdings, but at what price points. Recent action in the markets are telling us that the level is closer to $20-$30 for silver. Gold on the other hand has not reacted like silver which bodes well for its future.

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