Silver is one of the most underappreciated assets in recent years, but there are signs the grey metal may jump 420% again. The last time silver prices made such extraordinary gains was from 2009 to 2011 when silver nearly topped $50.00 an ounce. The indicator that foreshadowed that rise is sounding the alarm again, saying silver prices are headed sky high.
Just to clarify, you won’t get rich overnight. Don’t believe any of those hucksters that tell you it’s possible to multiply your money in a single day; investing takes skill and patience.
Today’s volatile market is run roughshod by high-frequency traders who thrive on swinging prices. Stability is anathema to their business model. It’s become increasingly difficult to time the market with success since HFT traders invaded the market.
Hard assets, however, provide insulation from those problems.
Silver: The Ultimate Hedge Against Uncertainty
Gold and silver used to underlie the global financial system; a relationship that kept their values fairly stable. However, prices shot through the roof when the U.S. dollar moved to a fiat system in the late 1970s. Rather than providing a basis for the U.S. dollar, precious metals were used to hedge against a dollar collapse.
Silver – Spot Price Chart
That being said, silver’s been down in the dumps since 2011, falling nearly 70% in just four years. Part of the downward pressure came from the Federal Reserve.
The central bank engaged in an unprecedented level of monetary stimulus from 2008 onwards, bolstering support for the U.S. dollar at a time when faith was the rarest of commodities. Investors drew confidence from the “easy money” policies of asset purchases and low interest rates.
They believed that monetary stimulus was the silver bullet. As a result, the need for an economic hedge became more important than ever. Unfortunately, the market was too drunk on optimism to see it. Hence the drop in silver prices.
The Metric Predicted 420% Rise in Silver Last Time
The key indicator that foreshadows silver price gains is known as the silver-gold price ratio. Gold and silver tend to move as a pair over the long term, rising and falling in tandem. In the short term, however, prices can fall out of sync; meaning one of the metals is improperly valued.
Every time the silver-gold price ratio gets too high, it means silver is undervalued. Over the last 40 years, the grey metal averaged a 42.8 conversion rate with gold. History has shown that a rise in silver prices are all but guaranteed when the ratio tops 70. It’s sitting at 75 right now.
The last three times we saw the ratio cross 70—in 1997, 2003, and 2009—silver prices saw enormous gains. Investors who bought when the ratio peaked could have made an easy 70%, 200%, and 420% respectively.
(See featured Chart Above)
Why is the ratio so high? Like I said earlier, the Federal Reserve’s expansionary policies helped prop up a crumbling stock market and reinvigorate investment in equities. Broadening the money supply accomplished those goals. But it sapped the energy out of commodities.
The second reason (that I touched on briefly) is the impact of HFT on markets. Almost every transaction conducted on a public exchange is channelled through a toll both owned and operated by high-frequency traders. We didn’t know this until a few years ago.
In his book Flash Boys, Michael Lewis told the story of several Wall Street traders uncovering an elaborate scheme to game the stock market. HFT players were inserting themselves as intermediaries between the various stock exchanges around New York. (Source: Vanity Fair, April 2015.)
They would effectively scalp orders to an investor. If you wanted 100 shares of Apple Inc., an HFT firm would pick up the initial bid, race your signal to the exchange, buy the shares first, then offer them to you for marginally more.
If you’re wondering how that’s legal, well, join the club. That’s why people say the market is rigged. The natural consequence of HFT is more volatility in the market, as was exemplified by the Flash Crash in 2010.
Under those conditions, doesn’t it make more sense to buy a hard asset like silver? It’s underpriced and will protect against the chaos of stocks.
By Gaurav S. Iyer, IFC