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Did the silver bubble burst?

There are three reasons to believe that the silver bubble has burst.

From a price action perspective, what happened to silver last week was the classic burst-bubble pattern of a parabolic move up followed by a violent and swift decline.

Before 2011, silver climbed steadily.<span style="mso-spacerun: yes;"> </span>Starting in mid-January 2011, it surged 80 percent in just 14 weeks. Then, in the week of May 2 alone, it crashed 30 percent.

The margin requirement hikes of the silver market are another indication of a burst bubble.<span style="mso-spacerun: yes;">&nbsp; </span>

The margins determine how much you can borrow to buy silver futures &ndash; the lower the initial margin, the more you can borrow. Raising the margins of silver futures, in the microcosm of the silver financial market, is therefore similar to a central bank tightening monetary policy.

The CME has steadily raised the margins for silver financial futures from $5,000 in November 2010 to $21,600 last week.<span style="mso-spacerun: yes;">&nbsp; </span>In the process, they crashed the market.<span style="mso-spacerun: yes;">&nbsp; </span><span style="mso-spacerun: yes;">&nbsp;&nbsp;</span><span style="mso-spacerun: yes;">&nbsp;</span>

This is similar to the crashing of other bubbles caused by interest rate hikes, like the dot-com bubble and the subprime mortgage crisis.<span style="mso-spacerun: yes;"> </span>In all these cases, bubbles were fueled by excessive liquidity, i.e. the ability to borrow too cheaply.<span style="mso-spacerun: yes;"> </span>Once that liquidity is tightened, the bubble bursts.<span style="mso-spacerun: yes;">&nbsp; </span>

Moreover, because the liquidity is gone, an ensuing bear market takes place.

Still, many silver bulls remain unfazed.They admit that silver prices got ahead of fundamentals and a correction was overdue.<span style="mso-spacerun: yes;">&nbsp; </span>However, fundamentals &ndash; namely physical demand from Asia and the Federal Reserve's loose monetary policy &ndash; remain firmly in silver's favor in the long-term.

The crash of May 2, 2011, then, will just be a blip in silver's long-term rally.

However, there is a counterargument to the bulls' case that points to the burst and demise of silver: the end of QE2 on June 30, 2011.<span style="mso-spacerun: yes;">&nbsp; </span>When that happens, the US dollar may strengthen and continue to rise in anticipation of an ensuing rate hike.<span style="mso-spacerun: yes;"> </span>Precious metals, therefore, will likely decline versus the dollar.

Federal Reserve Chairman Ben Bernanke recently noted that he is not inclined to roll out another round of QE.<span style="mso-spacerun: yes;"> </span>The most recent non-farm payrolls data also points to no further QE.<span style="mso-spacerun: yes;">&nbsp; </span>

June 30, then, may mark a significant turning point in the Fed's monetary policy to the detriment of silver.

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Publication:International Business Times - US ed.
Geographic Code:1USA
Date:May 9, 2011
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