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Pop Goes the Silver Bubble

The real story about silver’s collapse is about prices and buyers.

By Chloe Lutts



... Then What?

Post-Bubble Investing


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Last week, I wrote about the Dutch tulip mania of the 1630s, still one of the most dramatic and instructive investment bubbles the world has ever seen.

I pointed out a few similarities to the recent housing bubble, the most striking of which was the emergence of financial instruments that allowed unqualified buyers to enter the market.

Coincidentally, just as I was writing about the inflation and popping of those bubbles, another bubble was imploding in dramatic fashion.

As you know by now, that was silver.

The immediate catalyst for silver’s plummet was CME Group’s announcement of several imminent increases in the margin required to purchase silver futures contracts. In the next few days, as higher margin requirements were implemented, silver futures prices plummeted 27%.

The higher margin requirements certainly posed problems for some small- and medium-sized silver futures buyers, who were forced to either increase the capital tied up in their silver trades, or reduce the size of their bets on silver. Some inevitably chose the latter, and silver prices slid, then tumbled.

However, as with the tulip and housing markets, the real story about silver’s collapse probably isn’t about margin requirements, but about prices and buyers. When silver’s fall is over--which could be now, or many months from now--I expect you’ll hear the same story I told last week. It’s a story about prices that rise so far, so fast, that they seem invincible, and of under-qualified buyers who are drawn in by the fantasy of getting rich overnight. Eventually, those buyers either run out, or they can no longer afford the ever-pricier object of their desire (silver is often called the poor man’s gold, but at nearly $50 an ounce last week, it wasn’t exactly cheap).

Finally, prices crash. The same sequence of boom and bust has occurred over and over again in virtually every investment market throughout the world for centuries.

Some analysts already are telling silver’s sad story. Shortly after the margin increases were announced, on May 4, American Wealth Underground Editor Michael Robinson wrote:

“Remember, I warned you that ‘hot money’ runs scared. I’m talking about day traders, momentum investors, speculators--the short hitters who just wanted to jump on the metals bandwagon. We’ve had so many amateurs getting into silver in the past few weeks I’m actually glad that many of them will get flushed out. Then the serious investors can get back to work.”

The main question now is what price the “serious investors” can support. With tulip bulbs, the answer was many times lower than the price level hit at the top of the mania. But the non-speculative demand for tulips--i.e., demand from people who were actually planning on planting the bulbs in their gardens--was always fairly limited. With housing, the answer so far depends largely on region--it turns out there’s not actually that much demand for McMansions in the Arizona desert, but there are still plenty of real buyers for New York City apartments.

As for silver, there will always be some demand for jewelry and industrial applications, and investment demand will hardly disappear. The fact is, emotion always colors the market’s expectations, because economic value depends on the subjective opinions of people. There’s no exact formula that proves what silver should sell for ... but I wouldn’t be surprised if this precious metal continues to lose more and more of its luster.

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Speaking of post-bubble real estate markets, there are a few that are turning into great places to invest--and not just for bottom-feeding penny stock speculators. The latest Dick Davis Dividend Digest, which came out last Wednesday, featured a bumper crop of Real Estate Investment Trusts, or REITs, operating in niche markets.

REITs own rental properties, so many of them bounced back from the real estate crash, as buyers turned into renters. REITs are structured to pass on the majority of their rental income to shareholders, making them great for investors seeking regular income. Of course, the amount of income they pass on depends on how much they take in--and many were forced to cut their distributions sharply during the Great Recession. But a few years of gradual improvements in some rental markets have allowed many U.S. and Canadian REITs to begin increasing their distributions again. In the Dividend Digest, I quoted Barclays Capital REIT guru Ross Smotrich, who recently wrote: “Some raised dividends in 2010, and we expect most REITs to face upward pressure on payouts this year. Across our coverage universe, we forecast a 2011 average dividend increase of 9%.”

Of course, all is still not well in real estate land, so you have to pick the right REIT in the right market. The ones featured in the Dividend Digest last week came from several of the most resilient sectors, including multi-family apartment communities, Canadian shopping centers, New York City office space and medical facilities. Today’s Investment of the Week comes from the latter category. It was recommended by Jack Colombo, editor of Richard Lehmann’s Forbes/Lehmann Income Securities Investor:

Senior Housing Properties Trust (SNH) is a real estate investment trust, or REIT, which owns senior independent living and assisted living communities, continuing care retirement communities, nursing homes, wellness centers, and medical office, clinic and biotech laboratory buildings located throughout the United States. The majority of their properties are leased to unaffiliated tenants. As of December 31, 2010, they owned $3.8 billion of primarily senior living properties with approximately 27,000 living units located in 36 states. For their fourth quarter and full year 2010, Senior Housing Properties reported net revenues of $97.3 million and $339.1 million, well above the $87.3 million and $297 million reported for the same periods in 2009. Net income fourth quarter and full year 2010 was $33.9 million and $116.5 million. Fourth quarter and full year 2009 net income was $32.1 million and $109.7 million. Funds from Operation (FFO) improved in both the quarter, $57.2 million vs. $52.4 million, and full year 2010 $218.8 million vs. $206.8 million. ... This is a good security for a low- to medium-risk growth and income portfolio. Buy at or below $24.00.”

Click here to learn more about SNH and other high-potential recommendations from Dick Davis Dividend Digest.

Wishing you success in your investing and beyond,

Chloe Lutts
Editor of Investment of the Week

Cabot Editor