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Silver's Epic Mean Reversion

Adam Hamilton
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May 01, 2020

Silver is powering higher in a new bull market after getting clobbered in March's stock panic. Investors have been flocking back to silver in the aftermath of that ultra-rare extreme-fear event. That brutal selloff also utterly wiped out speculators' upside bets in silver futures, giving them massive room to buy back in. After being pummeled to record-low levels relative to gold, an epic silver mean reversion higher is underway.

A couple weeks ago, I wrote a popular essay "Big Silver Bull Running!". It explained what happened to silver in this recent COVID-19 stock panic, and why silver soared in its wake. Sucked into that blinding fear maelstrom, silver was thrashed to a miserable 10.9-year low. This metal plummeted in a near-crash, fueled by speculators' fastest long purgeever witnessed! That exhausted their selling, totally resetting longs.

That meant these super-leveraged traders' capital firepower was fully available to buy back into silver. And much more bullish than that, strong and relentless silver investment demand emerged since that mid-March collapse. That's evident in the soaring silver-bullion holdings of silver's leading exchange-traded fund, the SLV iShares Silver Trust! This dominant silver ETF is the best daily proxy for global investment demand.

The remarkable capital inflows pouring into silver through that major SLV conduit from American stock investors were explored in depth in that recent essay. But with surging investment demand as evident in SLV's holdings its primary thesis, I only had room to tangentially touch on another very-important bullish silver factor. That's silver's relationship to its overwhelmingly-dominant primary driver, gold price trends.

This white metal has always tended to mirror and amplify whatever is happening in the yellow one. Silver effectively acts like a gold-sentiment gauge. Traders' enthusiasm for silver mounts when gold is rallying on balance, leading them to bid silver higher well-outperforming gold. Since the world silver market is tiny compared to gold's, worth just a small fraction in any given span, capital inflows fuel outsized silver gains.

But when gold is generally drifting lower, or grinding sideways long enough to shift sentiment to bearish, silver is abandoned. Speculators and investors alike are only interested in silver when they expect gold to continue materially advancing. With silver joined at the hip with gold psychologically, it tends to leverage significant gold moves by 2x to 3x. And where silver trades relative to gold is analogous to its valuation.

The best time to buy silver is when it is abnormally-inexpensive compared to prevailing gold levels. That can be measured through a simple construct called the Silver/Gold Ratio. But dividing silver prices by gold prices yields tiny hard-to-parse decimals like 0.0089 this week. So I'd rather use an inverted-axisGold/Silver Ratio instead, which yields the same data in a much-easier-to-understand format like 112.1x.

The recent stock panic's extraordinarily-extreme impact on silver is really illuminated by this SGR proxy. This chart shows how silver has fared relative to gold over the last decade-and-a-half or so. When this SGR line is rising, silver is outperforming gold. The opposite is true when the SGR falls, gold surpasses silver. This chart is jaw-dropping, revealing exceedingly-anomalous SGR levels which are wildly bullish for silver!

When silver plummeted to that extreme 10.9-year secular low of $11.96 on March 18th during the stock panic, the SGR soared to 124.1x! In other words, it took 124.1 ounces of silver to equal the dollar value of a single ounce of gold. That radical collapse literally forced the SGR off the charts! For over a century, about 100x was the ultra-rare SGR edge-case limit. Now all the long-term SGR charts have to be redrawn.

Our daily silver and gold data extends back to June 1969, an immensely-long 50.9-year secular stretch. Before March 2020's stock panic, the worst SGR witnessed in that past half-century was 100.3x way back in February 1991. That only lasted two trading days before silver mean reverted back higher relative to gold. Our monthly silver and gold data runs much farther back to 1915. The SGR hit 97.3x in 1940 and 1941.

So in the 105 years leading into March 2020, the SGR had briefly challenged 100x precisely twice. And I've seen multi-century silver and gold charts cobbled together despite data becoming increasingly sparse the farther back in time peered. They imply this crazy 124.1x seen in mid-March was an apocalyptic all-time-record low in silver relative to gold! We just witnessed something so extreme it has never happened before.

Speculators' most-extreme silver-futures long dump ever fueled silver's near-crash, which obliterated this white metal to its most-extreme lowest levels ever compared to prevailing gold prices. Silver had never been cheaperrelative to gold! This wildly-unprecedented anomaly is incredibly bullish for silver. All past low-silver-price SGR extremes have been followed by massive mean reversions higher in subsequent years.

The last modern example came after the previous stock panic in October 2008. These ultra-rare selling events spawn such overwhelming fear that they suck in everything else including gold and silver. In the same single-month span where the flagship US S&P 500 stock index plummeted 30.0%, silver collapsed 32.6%! That catapulted the SGR to 84.1x that month, which was a 13.6-year SGR high or silver-to-gold low.

Financial markets abhor extremes in long-term relationships. They not only never last long, but prices almost immediately start mean reverting back towards normal ratiosafter they are dragged way out of whack by anomalous shocks. And there is nothing more extreme than ultra-rare stock panics. The epic fear necessary to fuel them is so far beyond normal that there have only been 3 in the last 113 years!

The incredible carnage the frantic stock-panic mass selling inflicts on silver only lasts as long as peak fear in stock panics. And that is really fleeting since extreme fear quickly burns itself out. Once that initial overwhelming wave of fear passes, silver immediately begins mean reverting back higher absolutely and relative to gold. Silver bull markets grow enormous after stock panics, mean reverting before overshooting.

The Silver/Gold Ratio, and indeed many long-term price relationships, are like pendulums. Equilibrium is the long-term average, analogous to a pendulum hanging straight down at rest. The farther a pendulum is pulled to either side, the extremes, the faster and more forcefully it swings back down into its arc's bottom mean. But its kinetic energy, like momentum in the markets, propels the pendulum to the opposing extreme.

In the years leading into late 2008's stock panic, the SGR averaged 54.9x. That was right near the long-term secular mean as well, which ran 54.5x between 1970 to 2007. So for many decades both gold and silver miners used an SGR of 55x to convert byproduct production of their secondary metal into equivalent ounces of their primary one. When a relationship exists for decades, there's good fundamental reason.

But like that pendulum, silver prices relative to gold's didn't just stop near 54.9x after silver's super-low extremes during 2008's stock panic. Instead they kept powering higher long after the mean, overshooting proportionallyto the opposing one! If you pull a pendulum to the left, it's going to swing back to roughly the same height on the right before running out of steam. Silver's last post-panic bull market was huge.

In absolute terms silver more than quintupled out of its stock-panic lows, skyrocketing 442.9% higher over the next 2.4 years into April 2011! Silver far outperformed gold in that post-panic mean reversion and overshoot, with the panic-bottom 84.1x SGR blasting through that longstanding 54.9x mean to soar way up to 31.7x when that post-panic silver bull ultimately crested! Silver's potential after stock panics is epic.

Investors flood back into silver for years after these ultra-rare extreme-selling events deeply scar them psychologically. A stock panic is technically a 20%+ S&P 500 plummeting in 2 weeks or less. Falling that fast spawns such mind-boggling fear that the total decline is often around a thirdin about a month! When stock investors suddenly and catastrophically lose that much of their wealth, they are forever changed.

They remember the wisdom of prudently diversifying their stock-heavy portfolios instead of foolishly being all-in stocks. So they gradually increase their virtually-nonexistent pre-panic allocations in gold and silver over the subsequent years. The precious metals are fantastic diversifying assets because they tend to rally on balance when stock markets are weakening or expected to. Silver can be more attractive than gold.

After stock panics, battered investors desperately want to be made whole again. After a 33% loss, getting back to break-even requires a 50% gain! And silver's upside potential is much greater than gold's simply due to the relative sizes of their markets. Think of these like market capitalizations of individual stocks. The smaller any market, the faster prices can be bid higher on any given capital inflows from investors.

The latest-available data for both world gold and silver demand is full-year 2019's. According to the latest report from the World Gold Council, global gold demand last year ran 4,355.7 metric tons. That was worth $195.2b at 2019's $1394 average gold prices. The Silver Institute's latest data pegs world silver demand at 991.8m ounces in 2019. That was worth just $16.0b at last year's average silver prices running $16.18.

So the global silver market is only about 1/12th as large as the world gold market! That means any given amount of capital flowing into silver can exert about 12x the upward-price impact of that same amount moving into gold. That's the major reason why silver prices tend to amplify material gold-price trends by 2x to 3x. Devastated stock investors following panics also like the relative perceived cheapness of silver.

With an ounce of silver or SLV share costing far less than on ounce of gold or GLD share, investors looking to diversify in precious metals think they are getting more bang for their buck in silver. They like to own more ounces or sharesrather than less, which makes them feel like their wealth has better potential to grow again. And once silver runs, investors love chasing winners so buying begets more buying.

All these post-stock-panic dynamics that helped silver quintuple after that last stock panic in late 2008 still exist today. And with that far-more-extremeall-time-record-high SGR in mid-March, today's new post-panic silver bull has way more room to mean revert and overshoot to even-greater gains! If investors continue migrating back into silver in coming years like after the last stock panic, silver's upside potential is epic.

Today's secular gold and silver bulls began marching out of deep many-year lows in December 2015. From then until February 2020 prior to March's extreme stock panic, the SGR averaged 79.0x. That is really high historically, as silver was languishing low and out of favor for much of recent years. But there's no doubt the panic-stricken SGR has to at least shoot back up to that quasi-normal level in coming months.

With today's prevailing gold prices near $1717, a mere mean reversion implies silver powering back up to $21.74. That's another 41.9% above current levels, which would make for a good upleg. Silver's maiden upleg in this bull peaked at 50.2% gains, while its most-recent upleg this past summer ran out of steam at +40.0%. But once silver regains that much ground relative to gold, its momentum should carry it much farther.

A proportional overshoot, the SGR pendulum swinging back towards the opposite extreme, portends far-greater post-stock-panic silver-bull gains. Silver would blast so much higher in that scenario that it would drag the SGR back down to 33.9x. That wouldn't last long, it would mark the unsustainably-euphoric parabolic peaking of this silver bull. The last post-stock-panic bull shot the SGR even lower to 31.7x before failing.

At that same $1717 gold and this proportional-overshoot 33.9x, that implies silver soaring all the way up to $50.65 before this new post-stock-panic bull gives up its ghost! That's certainly not unreasonable either, as silver peaked at $48.43 in April 2011 when that last post-stock-panic bull went terminal. That would make for a quadrupling out of March 2020's extreme silver lows, a 323.5% bull run in coming years!

But running SGR mean-reversion-overshoot scenarios off today's gold prices is way too conservative as it ignores gold's own bull market. As I explored in an essay a few weeks ago, gold investment is soaring as well in this stock panic's wake. This is also likely to persist for years, driving gold much higher. Gold will prove way more attractive than normal for years to come given the near-hyper-inflation gushing from the Fed.

In literally just 6 weeks from mid-March to late April, the Fed's balance sheet exploded an eye-popping 52.4% or $2,261.2b higher! This central bank is printing money like there's no tomorrow to monetize the colossal amounts of Treasuries the US government is issuing. It is trying to fight the terrible depression being forced upon us by governments' own absurd draconian overreactions to the COVID-19 pandemic.

Those trillions of new dollars being paid directly to Americans through loans and grants are going to be competing for vastly-slower-growing goods and services on which to spend them. That is going to really bid up general price levels, unleashing stagflation fears among investors! This near-hyper-inflation will make gold and silver far more attractive and essential for portfolio diversification than after the last stock panic.

Only time will tell how high gold ultimately flies in this radically-unprecedented broken world, but after that last stock panic in October 2008 gold powered 166.5% higher over the next 2.8 years. So a doubling out of mid-March's panic low of $1472 seems reasonable if not conservative. $3000 gold is certainly achievable in coming years! But let's assume gold somehow only climbs 50% in this post-panic bull, hitting $2200.

At $2200 gold, a 79.0x silver-bull-mean SGR yields silver levels of $27.84. That's 81.7% higher than this week's silver levels in a mere mean reversion. If the inevitable overshoot fails early and just carries silver back up to its decades-old 55x SGR average, we'd be looking at a $40.00 silver target. And at that full proportional mean reversion of 33.9x, $2200 gold would imply silver soaring to new record highs near $64.90!

While these post-stock-panic silver-bull price targets are interesting, they really aren't very important. Even if you only think silver has the potential to double or triple out of its recent stock-panic low, which would carry it back up to $23.92 to $35.88, you should be establishing a material portfolio allocation. Maybe that's 5%, compared to the 10% to 20% every investor should always have deployed in far-less-volatile gold.

And if silver is starting an epic mean-reversion-overshoot bull run higher out of the most-extreme SGR levels ever witnessed by far, the gains coming in the major silver miners' stocks will dwarf silver's! They tend to amplify silver's own moves by an additional 2x to 3x. So about a month ago we started adding new trades in fundamentally-superior silver miners in our newsletters, buying low before they soar far higher.

This new post-panic silver bull's upside potential is amazing! Silver's shocking all-time-record low relative to gold is just one factor. Speculators' extreme silver-futures long purge left them positioned to be huge buyers. And investment buying has already been strong and relentless in the stock panic's wake. Add gold itself heading way higher on big investment buying and near-hyper-inflation, and silver looks incredible.

We do all the hard fundamental stock-picking work at Zeal, winnowing the silver-stock field to uncover the likely big winners. And we're currently still redeploying in these fundamentally-superior gold and silver stocks as their latest upleg grows, which are recommended in our popular weekly and monthly newsletters. The unrealized gains in our new trades deployed since mid-March are already running up to 60% this week!

To profitably trade high-potential gold and silver stocks, you need to stay informed about broader market cycles driving gold. Our newsletters are a great way, easy to read and affordable. They draw on my vast experience, knowledge, wisdom, and ongoing research to explain what's going on in the markets, why, and how to trade them with specific stocks. Subscribe today and take advantage of our 20%-off sale! Get onboard so you can mirror our great new trades being layered in for silver stocks' next mighty upleg.

The bottom line is silver is due for an epic mean reversion higher relative to gold in coming years. The recent stock panic obliterated silver prices to their lowest levels ever seen compared to gold! Historically, similar but milder silver-low extremes were soon followed by massive mean-reversion-overshoot bulls. After the last stock panic in late 2008, silver more than quintupled over the next couple years or so.

Silver's new-bull-market upside potential after this latest stock panic looks considerably bigger. Silver-futures speculators' mass exodus during the panic gives them vast room to buy back in. And investment-capital inflows have already been strong and relentless in this panic's wake. Silver should amplify gold's own post-stock-panic bull on surging investment demand for prudent diversification and on Fed-inflation fears.

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May 01, 2020
Adam Hamilton, CPA

Thoughts, comments, or flames? Fire away at zelotes@zealllc.com. Due to my staggering and perpetually increasing e-mail load, I regret that I am not able to respond to comments personally. I will read all messages though and really appreciate your feedback!

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