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Why Silver's Run May be Far From Done

By Timothy Wood       Printer Friendly Version Bookmark and Share
Apr 1 2011 12:07PM

( -- Many professional investors spend a lot of time and treasure tracking reversions to the mean. In its most simple formulation, it means that if, say, the gold price, is at an extreme distance from the average, then there is a high probability that the next price points will be at a less extreme distance. The good news is that silver prices have a long way to go before they risk "extreme" territory.

That's all very well, but the mean is relative to the period under consideration. In the case of commodities, it's not worth much if you are only working with a decade or so of data. So we dug out some very long-range data and adjusted it to eliminate the effects of inflation.

It's not perfect by any means because the data is affected by a ton of hidden "noise" - changes in monetary systems, global power shifts, changes in global trade, technology advances, demographic changes, 'hedonic' statistics, and so on. But it's unrealistic to assume that all those variables could be adequately accounted for without introducing more and new problems. So it is best to keep it simple; a golden constant if you like.

Working with the available data, we find that silver prices have only now breached the 220 year mean. So silver bugs have a reasonable expectation that there is still room for one of those healthy speculative blow-offs that rockets prices to multi-decade highs.

To be sure, there is also bad news. Look how long silver prices languished below the mean; nearly 90 years. And before that it was a century above the mean. This is principally the result of a monetary phenomenon so silver investors need to be extremely cautious about over-interpreting the data.

We are literally in uncharted waters when it comes to silver. It has lately begun behaving like money again, yet the 2008 crash reminded everyone of silver's dependence on industrial consumption in a digital photo era.

The gold-silver ratio offers some additional comfort for silver bugs.

As the chart shows, silver has been slowly clawing its way back to the mean. Yet it has some way to go to reach the long-term average of 32.98 ounces of silver per ounce of gold, which could be accomplished with further increases in silver or a crack in gold prices.

Timing will be critical. Silver is bound to overshoot at some point and become excessively expensive relative to gold. However, the window to swap positions out of silver and and into gold will be very small if the last century is anything to go by. It's also worth buffering expectations with the reminder that silver and gold have already doubled twice since their annual average lows of 2001.

Whilst gold investors may be a little disheartened by how far bullion has soared above the mean, they should take comfort from the early signals that the Bretton-Woods era is sunsetting, and the experiment with floating currencies has gone very poorly, especially in a global economy where the senior partners are financially and fiscally distressed.

Timothy Wood



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