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Indicator Warns of 93% Collapse in Silver's Purchasing Power


While you can compare the ratio of real estate to silver directly over a relatively short time, one can improve upon the model by addressing the subtle downward secular trend in the ratio.

A recent column about silver and stocks (Indicator at Level Where Stocks Have Historically Outperformed Silver by 1,928%) was written in order to provide a specific example on how to value an asset class of commodities which is notoriously difficult to value. Here, I will look at silver once again and use the same methodology to compare it to real estate. This will allow us to see how the fair value results of silver to real estate compares to the fair value of silver to stocks.

Over the course of many centuries, silver has underperformed inflation. There are two ways of looking at this. One is to say silver is extremely undervalued. The other is to say it has historically been a poor store of purchasing power.

What about real estate? There is a data series called the Herengracht Index which shows the prices of houses in Amsterdam going back to 1628. Robert Shiller also has a nice data set of United States housing which goes back to 1890. The Dutch real returns from 1628 to 1890 were 0.34% annualized. We then pass the baton over to Shiller, whose data suggests that real estate beat inflation by 0.23% per year from 1890 to 2010. Both data sets are telling similar tales -- real estate slightly outperforms inflation.

So while you can compare the ratio of real estate to silver directly over a relatively short time, one can improve upon the model by addressing the subtle downward secular trend in the ratio. It is time to bring out the Excel regression genie to work its magic.

Let's take a look at silver with the "fair value" regression line of the annual relationship to real estate and silver since 1890:

Silver is trading at the 98th percentile with respect to being overvalued. Only in 1979 and 1980 was silver more highly priced. This is a tale which many indicators tell over and over again. Yes, silver was more overvalued at the January 1980 top than it is now so it is possible that it may go higher. However, even if it does, it's extremely unlikely to last very long at those levels.

What does the silver/real estate regression suggest fair value of silver is?


Readers may be struck by that answer. In my past article (linked above), I performed the same methodology except instead of using real estate, silver was compared to stocks. The answer was $11.70.

The implications of this are profound. We have two completely different asset classes -- stocks and real estate -- whose data goes back 310 and 120 years respectively. Both regressions are coming up with a very similar answer with respect to the fair value of silver.

Within the silver:stock complex we examined two data sets. We looked at the silver:stock relationship going back to 1700 on an annual basis to give a broad historical overview. Then we looked at monthly data going back to 1800 and sacrificed a bit of robustness to offer more clues about how overbought silver was in a more intermediate time frame.

Unfortunately, it is rather difficult to obtain monthly real estate data going back to 1800 or even 1890. We will have to make do with median home prices from the US Census which starts back in 1963.

What does this series suggest fair value for silver is?


This is remarkably close to the $10.48 figure from the 1890 study. What is interesting is the same phenomenon played out when we zoomed from 1700 annual to 1800 in the silver:stock relationship. Those numbers were very close to each other as well.

As above, so below.

If you are suffering from data overload, here is a table which summarizes the different methods used and their results:

Using the monthly data is considerably more helpful at valuing silver in the middle of the year. At the April close, silver was at the 4th most above its fair value on a percentage basis (+345%) out of 580 months in the US Census series. This is the 99.48th percentile, behind only December 1979, January 1980, and February 1980. Those dates were within 21, 10, and 39 days from silver's multi-decade high. Here is how silver did after those dates to its February 1991 low:

As for buy signals, the most silver was undervalued by this metric was 62.33% below fair value on March 1963. Silver would proceed to go up 118% over the next 5.25 years. On October 1971 silver was 61.9% below fair value which preceded an over 3,000% gain in less than 8.25 years. As recently as January 2002 silver was 55.91% below fair value which set the stage for a respectable 1,072% rally in less than ten years.

Buy low. Sell high.

Many people are buying silver in expectation that the United States government will continue to print money and this will cause inflation. Despite all the printing, the largest component of inflation, real estate, has declined in value five years in a row. For whatever reason, many market participants believe silver is immune to such a phenomenon. It is not. When the silver to real estate regression model has reached recent lofty levels in the past, it has foreshadowed not only a nominal decline in silver, but an even more significant loss of purchasing power as well.

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