What signs are there of a bubble in silver (or other precious metal)?

I was planning on buying some small quantity of silver soon, but I noticed the price has doubled recently and thought "what goes up, must come down". How can I tell whether the new price is a trend, or whether it's a bubble soon to burst?

  • 11
    Know is a strong word. Nobody really knows. – fennec Apr 25 '11 at 18:41
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    I think the idea is most people don't know they're in a bubble until it bursts. – zippy Apr 25 '11 at 20:14
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    And those who do know it's a bubble won't know when it's going to burst. Those who happen to "predict" the burst will be celebrated by the media, but will fail to predict the next one. – James Roth Apr 25 '11 at 20:19
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    You'll be able to know in hindsight ;) – Patience Apr 25 '11 at 20:38
  • @fennec, @Patience, @others I removed that irksome word. Indicators would be helpful ... – C. Ross Apr 26 '11 at 11:06
up vote 12 down vote accepted

How I recognize a silver bubble:

  1. It seems like everyone is talking about their latest silver investment. This is similar to tech stocks in the '90s and real estate in the '00s.
  2. Your plumber is talking about how he is making a fortune in silver.
  3. Your brother-in-law is talking about how is making a fortune in silver.
  4. New investment products are being announced almost daily offering different ways to invest in silver - indexes, etf's, mining companies, securitization products, etc.
  5. Many investors talk about how you can't go wrong with silver. It's a "no-brainer".

I don't think silver is in a bubble.

You state:

What goes up, must come down

I'm not sure I agree with this. Yes, prices fluctuate. But most prices generally go up over time due to inflation - somethings more than others.

Was coffee in a bubble in early 2005?

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If you thought so then you would have missed this:

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Was gold in a bubble in Argentina in 2001?
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If you thought so then you would have missed this (sorry for the mismatching chart scales):
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Was gold in a bubble in Weimar in 1922?
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If you thought so then you would have missed this:
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Maybe US farmland is in a bubble since prices are rising rather dramatically. I don't think it is in a bubble since I rarely hear anyone talking about investing in farmland:

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  • Funny how this almost marked the peak. I wouldn't compare signs of a stock market bubble to precious metals. Precious metals are almost in their own class. You can't eat silver and the industrial uses don't justify its price. In general the amount of participation in precious metal "investment" will be much lower vs. the stock market. – Guy Sirton Nov 2 '14 at 18:42
  • I'm interested in the analysis you've done to come to the conclusion that the "industrial uses don't justify its price". – Muro Nov 24 '14 at 15:21
  • The first order approximation is to see how it correlates with gold and how it behaves in times of economic uncertainty. Look e.g. around the stock market decline of 2009. If industrial demand drives the price of silver you'd expect recession and economic concerns to send the price down. What actually happened is the opposite where people flee to gold and silver because they feel those precious metals hold some intrinsic value in their shininess. What is your economic explanation for the decline of silver? – Guy Sirton Nov 26 '14 at 5:48

The problem with commodities is that they don't produce income. With a stock or bond, even if you never sold it to anyone or it wasn't publicly traded, you know you can collect the money the company makes or collect interest. That's a quantifiable income from the security. By computing the present value of that income (cf. http://blog.ometer.com/2007/08/26/money-math/) you can have at least a rough sense of the value of the stock or bond investment.

Commodities, on the other hand, eat income (insurance and storage). Their value comes from their practical uses e.g. in manufacturing (which eventually results in income for someone); and from psychological factors.

The psychological factors are inherently unpredictable.

Demand due to practical uses should keep up with inflation, since in principle the prices on whatever products you make from the commodity would keep up with inflation. But even here there's a danger, because it may be that over time some popular uses for a given commodity become obsolete. For example this commodity used to be a bigger deal than now, I guess: http://en.wikipedia.org/wiki/Frankincense. The reverse is also possible, that new uses for a commodity drive up demand and prices.

To the extent that metals such as silver and gold bounce around wildly (much more so than inflation), I find it hard to believe the bouncing is mostly due to changes in uses of the metals. It seems far more likely that it's due to psychological factors and momentum traders.

To me this makes metals a speculative investment, and identifying a bubble in metals is even harder than identifying one in income-producing assets that can more easily be valued. To identify a bubble you have to figure out what will go on in the minds of a horde of other people, and when.

It seems safest for individual investors to just assume commodities are always in a bubble and stay away.

The one arguable reason to own commodities is to treat them as a random bouncing number, which may enhance returns (as long as you rebalance) even if on average commodities don't make money over inflation. This is what people are saying when they suggest owning a small slice of commodities as part of an asset allocation. If you do this you have to be careful not to expect to make money on the commodities themselves, i.e. they are just something to sell some of (rebalance out of) whenever they've happened to go up a lot.

  • This is what I was trying to say, but is much better worded than my answer. – KeithB Apr 25 '11 at 19:56

@fennec is right, no one knows.

Here's a link that may help: http://pragcap.com/silver-prices-display-some-bubbly-characteristics

I don't follow markets enough to comment, but I have read enough of Cullen's stuff to know he's not off his rocker.

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    It is always a good idea to provide a summary of any link you post as an answer. If the link should go stale, the answer becomes worthless without that summary. – George Marian Apr 25 '11 at 21:07

If markets were perfectly efficient, the price should reflect everything that is currently known about the future of a commodity. If it is known that silver is currently under-valued, then investors would be buying it -- driving the price up. Conversely, if silver is currently over-valued, then investors would be selling and the price would be going down. Added to that is emotion. If the price is currently trending up, then people expect it to keep going up, and the price continues to rise. Until enough people think it can't go any higher and start selling, which drives the price down. Since this is driven by emotion, it cannot be predicted when this will happen.

In my opinion, you're in a precious metals "bubble" when rising prices are driven by the people's desire the own the commodity without a reason other than "the market is going up". Usually "bubble" markets are fueled by lots of debt. IMO, this isn't a bubble.

I don't think that silver and gold values are shooting up like a rocket due to some orgy of speculation.

In my opinion, citizens are losing faith in the government and in the value of money itself. If you have money to save, most banks pay less than 1%. The government claims that inflation is nonexistant -- the inflation rate on a US Series I Savings Bond was 0.37% in November 2010. Yet most people are noticing escalations in price in things that dominate their budget -- fuel, healthcare, local taxes and food. I bought a pound of store-brand butter for $3.99 yesterday... that was $0.99 4-5 years ago.

People are seeing precious metals as a way to hedge against that. They're rational about it -- trying to protect assets is different than speculation. I think the question to ask is: "Is the US Dollar's value a bubble?"

  • That's an interesting answer. Instead of only comparing the value of silver to the value of the USD, why not compare it to other things too: e.g. other commodities, currencies, stock indexes, etc.? – ChrisW Apr 26 '11 at 13:09
  • Invest in that butter, for example :-) two doubles in 4-5 years, that's a winning investment ;-) – Havoc P Apr 28 '11 at 2:22

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