Since commodities offer no yield, it is difficult to easily determine if they are overvalued or undervalued. I have written quite a few articles about precious metals
that have made an attempt to put a fair value on gold and silver. The preferred method of choice is to compare the ratios of precious metals to a variety of other assets.
These articles have unequivocally come to the conclusion that precious metals are dramatically overvalued. Today we will look at silver’s ratio to cotton and see if it offers any more evidence to support this thesis.
King Cotton. While most people are unaware of this, a year ago cotton was the leader of the second phase of the commodities bull market. Cotton was up 54% in 2009 to silver’s 48%. In 2010 cotton led the way with a 91% gain as silver was up 83%. On March 7, 2011, cotton was up 51% for the year while silver was up 19% for the year.
Then the inevitable collapse. Cotton went into a 61% bear market in less than 10 months. Silver took the baton and enjoyed its brief tenure as media darling for a couple of months. On April 28, 2011, silver was up 60% for the year. Silver passed the commodity leader baton (i.e., the kiss of death) over to gold and promptly dropped 47% over the next five months.
Let’s look at the annual data to see the relationship of silver to cotton over the past 228 years.
The above chart takes a snapshot of the silver-to-cotton ratio as of December 31 for each year (except for 2012, which is as of February 28). The all-time high for the annual silver-to-cotton ratio was in 1979. The ratio of silver to cotton on December 31, 1979, was 0.389. The only year when the ratio reached even 0.24 at the end of the year was 2011, when it reached 0.303. This is the 99.5% percentile.
It would come as no surprise to see the silver army point out that this ratio could go higher. In fact, it already has. This argument was already anticipated, and the most recent monthly data point of 0.388 on February 29 was added to the above chart. As you can see, once the February 2012 performance is accounted for there isn’t a whole lot of upside left if this relationship holds to its 228 years of history.
While this chart gives a pretty good idea of the relationship of silver to cotton over the past couple of centuries, it isn’t as precise with respect to silver’s performance in the middle of each year. For this we sacrifice a bit of robustness (since the monthly data only goes back to September 1870) and use monthly data.
As mentioned earlier, the most recent data point is February 29 when the ratio was 0.388. This is the sixth-highest reading out of the 1,698 months of data since September 30, 1870. This equates to the 99.7% percentile.
Here are the top six readings and what happened next:
1. February 29, 1980 -- 0.427 -- This was silver’s monthly closing high for over 31 years. Silver proceeded to drop 90% over the next 13 years.
2. January 31, 1980 -- 0.426 -- Silver went up 1.5% in February 1980, then experienced the aforementioned 90% collapse.
3. August 31, 2011 -- 0.393 -- No upside. Silver went down 33% over the next four months before bouncing. For reference, silver closed at $41.62 that month so we are still way down from that level.
4. July 31, 2011 -- 0.392 -- Silver went up 4.4% the next month before the aforementioned 33% collapse.
5. December 31, 1979 -- 0.389 -- Silver peaked three weeks later and then dropped 91%.
6. February 29, 2012 -- 0.388 -- Silver has already dropped over 15% in less than two weeks from its Leap Day intraday high.
Now let’s take a look at recent silver/cotton ratio lows.
1. August 31, 1973 -- 0.033 -- Silver would go up 1,452% over the next 6.5 years.
2. February 28, 1991 -- 0.044 -- This was the month of silver’s daily low and the start of a secular bull market in silver. Silver would go up 1,198% over the next 20 years and two months.
3. October 31, 2003 -- 0.066 -- Silver would go up 877% over the next 7.5 years.
Buy low. Sell high.
At the end of February, the monthly ratio was only 10% away from its all-time high. That isn’t much upside.
As for the downside, the ratio was 0.066 as recently as 2003. That is 83% below the February level.
In summary, the silver-to-cotton ratio is yet one more study that concludes that silver is dramatically overvalued. It is also interesting to note that every time the silver/cotton ratio has reached the February level, silver has dropped by at least 32% to a daily low within three months in all five prior instances.
No positions in stocks mentioned.
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