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Is Buying Silver Risky?

Is Buying Silver Risky?
June 08
16:57 2011

Financial analysts typically use the mathematical calculation of an asset price’s volatility to represent the “risk” inherent in that asset’s market. And it’s no different for silver. Even though the silver market has attracted previously unheard-of levels of investment recently because market participants feel it is a “safe” place to park their money during times of economic uncertainty, don’t be fooled into thinking this “safe” asset has no risk.

As a matter of fact, since 2008, silver’s volatility has peaked twice above 50 percent, most recently when the CME raised margin requirements and spooked traders. When compared with other markets, however, silver can seem to be a little “safer.” Crude oil, for instance, has been averaging 40 percent volatility through the past few years, and the stock market (as measured by the S&P 500) is no better than the precious metals sector, either. It has posted an average volatility around 15 percent, but with more frequent spikes up to 24 percent.

It’s also worth noting that when crude oil and the stock market’s volatility peaked in early 2009 (at 108 percent for crude oil and 55 percent for the S&P 500), silver’s peak volatility of that timeframe at 67 percent had already passed in December 2008. This disconnect is actually a highly sought-after characteristic by traders who want to hold a basket of assets that perform differently at different times, therefore diversifying their overall portfolio and limiting their risk of loss at any one point in time.

Even though mathematical calculations of volatility may be the standard way to think about risk, they are pretty nebulous. It’s hard to wrap your mind around what risk means if it’s not laid out in dollar terms. If you assume the silver market’s returns follow a normal statistical curve, with what statisticians know about that normal curve, you can calculate a silver market with a $2 standard deviation has only a 5 percent chance of moving more than $3.30 per ounce in any one day. For a 5,000-oz futures contract worth $150,000, that’s a 5 percent chance of losing more than $16,500 of that total value in one day. However, it certainly doesn’t mean it can’t happen. In the current investment climate, it’s not rare for the silver market’s daily high and low to be $3 apart, and it’s certainly not impossible for it to move more than $15 in a day. The NYMEX exchange sets a nominal initial daily price limit of $1.50 for silver futures contracts, but it is expandable if trading justifies it, so effectively, your risk of loss in the silver market is infinite.

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