Thursday, February 24, 2011

Silver Bubble Construction Set

The following chart compares how much the price of silver is above its long-term inflation adjusted average price to the total amount of purchasing power lost owning 3-month treasury bills over the previous 5 years.

I'm assuming a tax rate of 30% on the t-bills and I'm also adjusting for inflation. I'm not adjusting the price of silver for taxes though (mainly because those taxes can be deferred).

The following chart attempts to find the correlation.

There's almost no correlation here. R-squared is just 0.04. Let's eliminate World War II from the analysis though. For a variety of reasons, silver was not an important metal of the war. If nothing else, there was a distinct lack of werewolves involved in the fighting. ;)

The correlation is pretty good now. R-squared comes in at 0.41.

As seen in the chart, silver isn't exactly cheap. It is well above the level we would expect to see based on the pain dished out to savers over the past 5 years.

Gaining 200% to avoid a 3% loss in purchasing power is a lot of fun.

Here's the main concern. We live in an overleveraged society and that chart screams leverage to me. Note that the scale on the y-axis is roughly 20x what it is on the x-axis. It can easily play out in reverse someday. Those who bought silver in 1980 and held for 5 years found that out the hard way.

If these charts have any merit, then silver is either in a bubble or silver has priced in a great deal of future pain for savers. Perhaps hindsight will show that it was a bit of both? It's just one more reason I've been willing to buy 30-year TIPS.

No easy answers here. I'm worried about stagflation, deflation, commodity bubbles, debt, trade deficits, budget deficits, unemployment, taxes, leverage, and so on. I'm just trying to navigate the minefield.

The most merciful thing in the world... is the inability of the human mind to correlate all its contents. - H.P. Lovecraft

It really doesn't feel all that merciful right now. I'd really like to know, or so I think. Nobody knows though. Maybe ignorance really is bliss. Sigh.

The financial markets generally are unpredictable. So that one has to have different scenarios... The idea that you can actually predict what's going to happen contradicts my way of looking at the market. - George Soros

Source Data:
FRB: Selected Interest Rates
USGS: Historical Mineral Statistics
Kitco: Silver


getyourselfconnected said...

I think you have it:
"It is well above the level we would expect to see based on the pain dished out to savers over the past 5 years."
"If these charts have any merit, then silver is either in a bubble or silver has priced in a great deal of future pain for savers."

Add in a leverage chart and the expansion of the FIRE economy and now we are getting someplace. The Bernank (and whomever comes after) wants 100% of any money you have not spent, spent on something and will force you to do so. Sick and sad but until the trend is broke it is what it is.

getyourselfconnected said...

I should have added I am in 100% agreement with mean reversion but means change if acted on by an outside force, our FED and/or system of ponzi finance. Beleive me, I would love to see silver at $2 an ounce, then things may make sense.

Stagflationary Mark said...


My mean revision theories are centered on toilet paper.

From what I can see, no leverage is being applied to toilet paper prices.

A silver hoarder should therefore worry most about what silver prices might do relative to toilet paper.

In other words, silver's nominal price might stay at $30 long-term, but if toilet paper prices rise by 200% then the silver hoarder won't be all that happy about it.

When I said that I felt gold was in a bubble at $1000, I also offered the disclaimer that it was relative to toilet paper prices.

I really don't think we'll ever see silver prices at $2 an ounce again. I'd be surprised if it even got back down to $8.

It's a moving target though.

Consumer prices are up about 17% since I bought silver in 2004. I paid $6.80 if memory serves. I'd certainly be willing to buy it back at $8 an ounce (and ride it for another "modest" 50% gain).

I can't for the most part though even if it was to happen. I've already allocated most of my capital in long-term TIPS and I-Bonds. As you say, Bernanke pretty much forced me to buy something. I did.

Stagflationary Mark said...

AllanF quoted Lenin in a recent comment.

The way to crush the bourgeoisie is to grind them between the millstones of taxation and inflation.

For some reason the The Lord of the Schemes popped into my head.

One Scheme to rule them all, One Scheme to find them,
One Scheme to bring them all and in the darkness grind them

getyourselfconnected said...

Wow, well said! Aside, I do have toilet paper stocked and by your pics more than you, HA!

Stagflationary Mark said...


Aside, I do have toilet paper stocked and by your pics more than you, HA!

We might just as well compare notes.

I have 20 packages of 2-ply at 2812.5 square feet each. That's 56,250 square feet. There are 43,560 square feet in an acre.

I've therefore got 1.29 acres of toilet paper (about 10 years worth at current consumption rates). How many acres do you have? Hahaha!

Good grief. The things Bernanke makes us do. It may seem excessive but it costs less than half an ounce of gold. It isn't that I expect shortages. I just figure, "What's the harm?"

I certainly prefer it to 0.0% I-Bonds. At least I won't be taxed on toilet paper's inflationary gains. It is my septic system that will be *taxed* as another acre of paper eventually moves through it, lol. ;)

Miro said...

Lol @ the warewolfs :D
Yes, I am a trader and silver is one of my commodities.
I have suspected silver is in a bubble infact I think it needs to shave at least $4 per unit to be a it's correct price...

Stagflationary Mark said...


Thanks for commenting! :)

Anonymous said...

Very few people on this earth understand Silver
As I write this, Silver is at $45, up $15 bucks since this article was written just eight weeks ago.
The internet is a wonderful thing. You can find articles written over the past few years saying silver was overbought at $12, at $15, at $18, at $20 at $30.. The long awaited correction the "experts" keep warning us about never comes.

None of these "experts" understand the first thing about what is driving silver.

Stagflationary Mark said...

This post was intended to show how a silver bubble is formed. I'd say that since silver is up 33% in just 8 weeks the article still has merit.

Stagflationary Mark said...

I would also point out that you have decided to capitalize silver as if it is a holy metal worthy of our worship. That would imply to me that you think silver is good at any price. Time will tell.