Sunday, October 23, 2011

Silver bubbles and speculative demand

It seems like the silver market may have returned to normalcy. The year has been anything but normal. It has been pushed dramatically by speculative flows.

After pushing up toward $50/ oz, we are now in the low $30's/oz. Silver has had a dramatic increase in its beta relative to gold. It has moved close to 2 in the last 2 years from a previous level of approximately 1.35 for the previous five years. More recently, the beta has started to move lower.

Silver has had an unusual year broken into four parts. Part one was the speculative run-up through the end of April. The bubble burst with and diverged from gold. Part two was the consolidation through September when the market broke a second time in concert with gold which was part three. The current part four is the second consolidation.  The breaks in price have been associated with CME margin increases. A rapid combination of five margin increases raised margins by 84%. The September break was matched with another margin increase. The COMEX through the CME clearinghouse forced liquidation of the silver which changed the mix of players. This stopped the increases in speculative activity.

What is the feedback between margin increases and market price changes? Margin increases are usually associated with increases in volatility and volatility increases will usually lead to a shake out of speculation. The risk increases relative to reward, but a clear margin increases translate into real cash. There is more money needed to hold any position; consequently, there will be an exit by speculative players.

With an exit of marginal speculative players, there will be a return to more normal relative price linkages. Yet, the issue of why there was strong demand has not been addressed. The demand for poor man's gold still exists.

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