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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?
How I recognize a silver bubble:
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?
If you thought so then you would have missed this:
Was gold in a bubble in Argentina in 2001?
If you thought so then you would have missed this (sorry for the mismatching chart scales):
Was gold in a bubble in Weimar in 1922?
If you thought so then you would have missed this:
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:
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.
@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.
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?"
