THE SILVER ROUT / THE WALL STREET JOURNAL REVIEW & OUTLOOK ( VERY HIGHLY RECOMMENDED READING )

REVIEW & OUTLOOK

MAY 5, 2011.

The Silver Rout


Commodity boom and bust in a weak-dollar world.
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This week's rout in the silver market has commodity bulls running for cover, and everyone else wondering if those old devil speculators are manipulating the market. We'd say this is the kind of volatility you get in a financial market defined by too easy money and dollar uncertainty.


The silver price decline of nearly 20% in three days to $39.58 a troy ounce is certainly an attention-grabber, though perhaps less so when you consider that Friday's close of $48.584 was a 31-year high for gold's less-lustrous sister. As recently as February, silver cost $27.


The precious metal has long been a favorite of speculators, with the Hunt brothers famously trying to corner the market in 1979-80, much to their financial chagrin. But global commodity markets are tough to corner, even one as thinly traded as silver.


Silver's recent run-up is part and parcel of the commodity boom that has accompanied the Federal Reserve's great reflation gamble. As the dollar has fallen in value, the price of commodities traded in dollars has risen nearly across the board. The world's investors are looking for dollar hedges, and metals are always a favorite in such periods. Silver doesn't pay interest and has to be stored, so unless you need it for a commercial use it is mainly a dollar hedge. Speculators naturally join the rush, and what goes up with irrational exuberance often comes down with a thud.
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Silver's decline, and this week's overall commodity correction, may thus be a useful economic warning. While no doubt the abrupt fall has caught some traders with big losses, the bigger danger is a long-term mania that leads to a far bigger misallocation of capital.
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This is what happened in the housing bubble, and it is what we have begun to see with the boom in such weak-dollar alternative investments as land prices, foreign currencies, and commodities, especially silver and gold.
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Betting on such investments is risky business and may end up unhappily. But such speculating, such boom and bust, is what happens when no one trusts the value of a fiat currency run by a wide-open Federal Reserve.



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