What’s attractive about financial markets is that from time to time we become participants in historic events. This was undoubtedly Friday’s silver crash. I don’t invest in precious metals myself, but it was a valuable lesson for me.
It is true that I do not have precious metals in my portfolio – neither in physical nor “paper” form – but I have been observing the recent events on the gold and silver markets with a flushed face. Over the past weeks and months, it has been difficult for me to understand what is happening to the world that makes “safe havens” increase in value as if there was no tomorrow.
After all, from the beginning of the year to last Thursday alone, the price of silver increased by over 70% after rising by 142% in the previous year. I was still somehow able to understand this. Of course, silver used to be money, but for several decades it has been a speculative industrial metal rather than a source of value. But gold?! January’s 30% gain was preceded by last year’s 65% rally. We haven’t seen anything like this since the late 1970s. That is, the times when “Solidarity” was born in Poland, the Soviets were entering Afghanistan, and I was not yet born.
This is what a real meltdown looks like
The previous increases in quotations on the metals markets (because not only gold and silver, but also platinum, palladium, copper and zinc rose in price) could still be explained somehow. Which is what analysts bravely tried to do, recalling the motive of escaping from the dollar and US treasury bonds, the escalation of geopolitical risk by US President Donald Trump (who suddenly demanded Greenland) or simply talking about “unstable times”. And then the crash happened.
On Friday, January 30 silver futures dropped by 28% and gold by nearly 11%.
Supposedly, in both cases, these were the largest daily declines in history. In the case of gold, we saw a break of a similar scale only in 2013 and 1983. For silver, daily declines of 10-20% were not uncommon, but -28% in one day has never been seen before. That is, for as long as the New York futures market for both metals has existed – since the 1960s. Moreover, it would be difficult to expect that gold could lose so much at a time when it was simply money or a monetary anchor for paper currencies.
I must admit without hesitation that the mere observation of such great price changes aroused my curiosity and emotions. And yet I had no position on these markets! If I had it, I would probably perfectly understand the emotions of investors who have their own money invested in such a market. And even more so those who do it using financial leverage – that is, other people’s money. They left last Friday with their bags and have nothing to return to the market with.
Six lessons from the market crash
January’s precious metals crash taught me a few things. First, such crashes usually occur after an extended period of strong growth. Prices collapse only when too many investors succumb to euphoria and put a lot of money (not necessarily their own money, which will be discussed in a moment) on one horse. Because even the fastest horse will stumble someday.
Secondly, with such strong declines, everything happens very quickly and at unpredictable moments. It was enough to literally take your eyes off the chart for a few minutes for the prices of gold and silver to become several percent lower. Moreover, this movement was not linear at all! During the day, there were rebounds of several percent, after which the market returned to declines.
Third, everything suddenly started falling in the financial markets. Bitcoin – down. Crude oil – here you go: -5%. Stocks down. In fact, initially even American treasury bonds lost their value. Only the dollar gained. It was difficult for me to understand why the discount in one sector spread so quickly to other markets. Analysts pointed this out with the following maxim: when volatility increases, the correlation of all asset classes tends to one – it sounded a bit like a quote from the movie “Fightclub”.
It turned out that sudden movements in “large, liquid” markets can spill over to other asset classes. – Metals are widely held and actively traded, often using leverage. When prices fall quickly, it can trigger margin calls, forced selling and de-risking. When investors urgently need cash, they sell what can be liquidated most quickly, not necessarily what they would likewhich also puts pressure on other liquid markets (stocks, currencies and even some segments of the bond market) – explained Charu Chanana, chief investment strategist at SaxoBank.
The words “leverage” and “margin” are key here. When you invest other people’s (i.e. borrowed) money, each drop has multiplied effects on your portfolio. At -20%, a leverage of 5:1 is enough to lose all your capital. And usually investors use even greater leverage, where a change of even a few percent can “clear” the security deposit. If you do not add cash then the broker will close your position. Therefore, you must liquidate even those assets that you did not want to sell. Easy?
Fourth, even solid diversification will not eliminate portfolio volatility. I have always been told that you buy gold to diversify your portfolio of stocks and bonds. After all, the royal metal usually gains in uncertain times, when declines prevail on stock exchanges. The word “usually” is key here. Because it turned out that there are days when everything falls apart. And even if we are secured with gold, bonds or “defensive” stocks, our portfolio still loses weight. And there’s nothing we can do about it. Even if you don’t have silver in your portfolio, a silver market crash could hurt your pocket.
Fifthly, it is worth keeping your emotions in check. For a long-term investor – like me – it is crucial not to let yourself be convinced that “everything is falling apart” and you need to immediately evacuate the market. When you see such declines, it’s easy to panic. And the one on the market is usually the worst advisor. Therefore, it is necessary to ask yourself one question: what has changed and will it matter in a year or two? If the answer is “nothing”, then you should do nothing. Just wait and see how the situation develops. Or maybe even buy such a heavily discounted item.
– Treating a big move as a long-term truth is common mistake number one. Sharp price changes look like news. But speed does not equal meaning, explains Charu Chanana from SaxoBank.
It is a difficult art to distinguish the noise caused by market mechanics (the effect of forced closing of leveraged positions) from the sound made by hitting the actual “foundations” of a given security.
Sixth, do not make decisions under the influence of high volatility. Apparently, during such declines, many long-term investors decide to sell not because their plans and expectations have changed, but because of the mental discomfort caused by such large losses. Such investors exit the market not because they believe they made a mistake, but so that they do not have to think about the accounting losses they are currently recording. This is one of those moments when it is no longer important whether we are right, but whether we made money.
– I will exit the market and re-enter when the situation calms down – that’s what many gold and silver fans might have thought. It could hardly have been a bigger mistake. They probably exited on Monday morning when prices reached their low and entered after (or during) Tuesday’s rebound when silver gained 15%. It was probably difficult to play it all worse and realize bigger losses.
To sum up, if you invest for a long-term horizon, you should not worry about these types of market shocks at all. There are days when even excellent portfolio diversification will not protect you from accounting losses. The only important thing is not to give in to emotions and not realize losses, hoping to “outsmart” the market. In practice, no one can do this. Even if he correctly predicts the coming crash, it is extremely unlikely that he will predict when it will occur.
“Investors who achieve long-term success are not those who have avoided every crash, but those who have avoided turning a slide into a decision they can no longer reverse,” Charu Chanana pointed out.
