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Silver: Don't Buy the Plunge

Silver fell from a shade under $50 an ounce to less than $35 in just four trading days last week. You would have expected such a breathtaking decline to put the fear of God or penury into the bulls who helped send silver on the parabolic rise that preceded it, but many are encouraging investors to try to catch the falling javelin or at least hang tough and not sell. That suggests that the euphoria has yet to be broken and that there are further losses to come.

Here is a typical comment, from a blogger named Avery Goodman, that shows how nonplussed some investors are by the swoon in silver: "The ongoing price drop represents an opportunity for people to buy silver at a price that is cheaper than it probably should be right now. We believe that this is exactly what a lot of smart people are going to do."
Goodman's rationale is that "the demand for physical silver is so high and the inventory is so low." Yes, that would be bullish, but he doesn't offer much evidence supporting his opinion.

Another blogger, Ashraf Laidi, offers a more fanciful reason for buying - that if financially moribund Greece drops the euro as its currency, "gold and silver could find their safe haven allure."

But the rumor of just such an event last Friday did nothing for silver, although it did coincide with a bounce in gold that retraced a modest amount of the plunge that that metal suffered last week. More important, it's unclear why precious metals would benefit from a development that would alleviate some of the uncertainty surrounding European finances.

As for why silver tanked in the first place, Goodman and many others highlight a near-doubling in margin requirements on futures contracts, yet it's more likely that the higher margin requirements are the result of the near tripling in the price of silver since last August. Other explanations include Osama bin Laden's demise and reports that hedge fund managers like George Soros were selling the metal.

Attributing the decline to bin Laden seems a tad ludicrous given that the stock market fell for much of last week in what was rationalized as heightened anxiety that pretenders to the Al Qaeda leadership might step up terrorist attacks to try to land the job. And hedge fund managers? Well, no one knows for sure what trades they make, but that excuse is at least plausible.

A better explanation for the plunge in silver is that the preceding rally displayed characteristics of a classic market bubble. Unfortunately for those unfazed by last week's trading, it's looking a lot like a bubble on the way down too.

Silver may snap back this week, but a popped bubble tends to retrace the entire initial advance and then some. That could take silver into single digits eventually and make $35 look like the good old days.

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