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Indicator at Level Where Stocks Have Historically Outperformed Silver by 1,928%


Indicators have recently suggested that silver is likely to offer poor returns over the next decade. The silver/stocks regression indicator offers additional evidence of this.

One can compare bonds, stocks and real estate to each other because they have yields. Commodities have negative yields. Despite this fact, commodities have done very well over the last decade. But how do you know when to sell? The answer is ratios. You can compare the ratio of a given commodity to stocks and real estate to see which asset class is overvalued. Let's take a look at silver and stocks.

In order to get the most robust data set, we will splice together a few series from the Ohio State University Department of Finance, and The stock data from the 1700s is from the UK and after 1799 it is from the US. This chart shows the silver/real estate ratio going back to 1700.

It would come as no surprise if a few silver aficionados use this chart as prime evidence that silver is going to trade at its "historical" level of 1.85 times the S&P. Yes, that would mean that silver would need to trade at $2,451 to equal its 1700 ratio.

A more rational person would surmise that stocks simply usually go up more than silver does. Since 1700, stocks have beaten inflation by over 1% a year while silver has underperformed inflation by 0.36% a year. Owning a profitable business is usually more lucrative than storing a piece of metal.

However sometimes storing a piece of metal is the way to go as exemplified by the last decade.

But since commodities offer no yields, how can you tell where they are at in the undervalued/overvalued cycle? The silver/stocks chart seems to be useless. There is a downward trend to the series. This is the core problem. We need a way to factor in the secular downward move in the silver/stocks ratio.

The solution is regression analysis. This allows for a coefficient which adjusts for the downward slope of the ratio.

So what is the fair value for silver?

The answer is $11.70. With silver trading in the single digits less than three years ago, this does not appear to be an outrageous claim.

Interestingly enough, if one runs a monthly regression of silver and the S&P going back to 1800 (rather than an annual ratio going back to 1700) the answer is $11.65. Silver is trading at its 98.4% and 99.0% percentiles with respect to being most stretched from its regression line in its monthly and annual ratios respectively.

The most recent article in this commodity series had a few indicators which suggested that silver would fall to the single digits by the next decade (see Indicators Suggest Silver Headed for Single Digits). Does this study negate those indicators?

No. The time to buy silver is when it trades far below fair value. For example, silver was most undervalued by the silver: stocks regression in July 1933. Silver was trading 83% below its fair value. Over the next year and eight months, silver increased by 116% while stocks started a 33% bear market that very month. Silver was trading 60% below fair value as recently as August 2000. By April 2011, silver was up 857% while stocks were down over 10%.

The most recent monthly close (April 30) was ranked #2,486 out of 2,525 months in terms of silver being an attractive investment. Silver went down at least 60% from the signal date all 39 times it got this stretched from the regression.

But wait, there's more. By August 31, 2000 in all 39 of those cases, silver lost its purchasing power relative to stocks by an astounding 95.13%. Or put in another way, stocks increased in value by over 20 TIMES relative to silver all 39 prior times silver was this overvalued!

For example, when the indicator reached this level, silver did its BEST (on a relative basis to stocks) with the September 30, 1983 reading. By August 31, 2000, silver was down 55% while stocks were up 813%. Let's say there are two people, one with $100 in silver and the other with $100 in stocks on September 30, 1983. The silver bug was down to $45 by August 2000. But the stock owner had $913 by that time. So the stock owner had over 20 times more money or 1,928%. And this was the BEST case scenario for silver.

As for the worst case, that would be February 28, 1980. Silver went down 86.5% over the next 20.5 years. Stocks went up 1,235% over the same time period. So the silver bug went from $100 to $13.50 while the stock owner went from $100 to $1,335. In this case, the stock owner had 98 times more money at the end of 20.5 years! That's 9,788% more money.

Asset classes go through cycles. The newly printed money does not have to go into precious metals. It can go into stocks, bonds, real estate and commodities. Past articles have analyzed indicators which suggested that silver is likely to offer significantly poor returns over the next decade or so. The silver/stocks regression indicator offers additional evidence to support this view. It seems that many participants in the silver market are using the 1979 bubble as the template for their investing strategy. However, anybody who bought silver in the 1980s, 1979, 1978, 1977, 1976, and 1975 or after January 1974 was down by February 1991.
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