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A Gold & Silver Top?
By
David Stanowski
The perfect way to buy and sell investments is to buy low and
sell high! Unfortunately, the age-old investment dilemma is how
to tell when a price is "high" or "low". What exactly does this
mean?
A high price is one that is substantially above a level of
prices that represents the "known value" of the investment. A
low price is one that is substantially below a level of prices
that represents the "known value" of the investment. Therefore,
the real secret to investing is in discovering how to determine
a level of known value.
Investments that produce earnings can develop an accurate
measure of known value by computing their Price/Earnings ratio.
Stocks, businesses, and developed real estate can all be
measured using P/E ratios. After P/E ratios are computed for
many years, it is easy to determine the average P/E ratio for
any investment, and then recognize when its P/E ratio is very
low or very high.
The astute investor sells high P/E ratios, because prices are
above known levels of value, and buys low P/E ratios, since they
are below levels of known value. This is because market history
shows that when markets are overvalued, they cannot be sustained
at these levels, so they revert back towards known levels of
value, and usually overshoot even further until they are
undervalued. The reverse is true of undervalued markets.
Of course, things are usually not that simple because, even
after prices are accurately gaged to be "high" or "low" they
will often continue to go even higher or lower; or they will
simply hold their current "high" or "low" level for a long
period of time before they reverse.
Investments that pay no earnings, like gold, silver, sugar,
cattle, and land, cannot use P/E ratios to determine their
value. The best way to determine the value of an investment with
no earnings history is to compute a long term moving average of
its prices. As the name implies, this "moving average" indicates
what the average price has been over a long-term period of time.
For the purposes of this article, weekly closing prices of gold
and silver were used to compute their 156-week moving averages.
These averages represent what investors were willing to pay, on
average, for and silver, over the last three years, which
is assumed to be a reasonable approximation of value, at any
given point in time. This is true since investors have been
willing to pay these prices for a long period of time, which has
established a baseline.
Figure 1 shows a plot of the difference,
in percentage terms,
between the price of gold, and its 156-week moving average from
the week of 01 January 1979 up to the week of 17 April 2006; so
it includes the great bull market of the 1970s.
http://www.thefinancialhelpcenter.com/GOLD156WK1.jpg
Figure 1
Gold's highest close occurred on the week of 14 January 1980 at
$823.00, where it was 260.77% above its 156-week MA; a point
where it was obviously grossly overvalued. (NOTE: The actual
inter-week high occurred during the week of 21 January 1980 at
$873.00.) This extreme over valuation lead to a plunge in price
to $304.20 on the week of 14 June 1982; where it was 36.42%
below its 156-week MA; a point where it was undervalued.
Figure 2 plots the same data, except that it begins on the week
of 14 January 1982, so as to eliminate the point where the 1980
top took place, to better illustrate more recent action.
http://www.thefinancialhelpcenter.com/GOLD156WK2.jpg
Figure 2
After the low, the week of 14 June 1982, rallies to $476.20
on the week of 11 May 1987, where it is 34.39% above its
156-week MA measure of valuation, and then makes a slightly
higher high on the week of 7 December 1987, 32.29% above the MA.
This amount of over-valuation lead to sideways to lower price
action for about 14 years to lows of $253.90 on the week of 23
August 1999, and $257.90 on the week of 26 March 2001. From
there a 5-year rally has pushed prises to $632.20; 47.04% above
its 156-week MA, last week!
One could easily argue that over-valuations of 35%, or less,
have contained all rallys for the last 25 years, and lead to
prices moving back to, and below the 156-week MA, which
currently stands at $429.96, so the next major move should be
down towards this level, and probably substantially below that!
The only thing that makes this far less than 100% certain is the
fact that over-valuations can always extend further than this in
both price, and time, as witnessed in 1980! However, the odds
greatly favor a large price drop more than a large rally!
Figure 3 shows a plot of the difference, in percentage terms,
between the price of silver, and its 156-week moving average
from the week of 01 January 1979 up to the week of 17 April
2006; so it includes the great bull market of the 1970s.
http://www.thefinancialhelpcenter.com/SILVER156WK1.jpg
Figure 3
Silver's highest close occurred on the week of 14 January 1980
at $40.50, where it was 423.73% above its 156-week MA; a point
where it was obviously grossly overvalued. (NOTE: The actual
inter-week high occurred during the week of 21 January 1980 at
$41.50.) This extreme over-valuation lead to a plunge in price
to $5.10 on the week of 14 June 1982; where it was 64.04% below
its 156-week MA; a point where it was undervalued.
Figure 4 plots the same data, except that it begins on the week
of 14 January 1982, so as to eliminate the point where the 1980
top took place, to better illustrate more recent action.
http://www.thefinancialhelpcenter.com/SILVER156WK2.jpg
Figure 4
After the low, the week of 14 June 1982, silver rallies to $9.41
on the week of 11 May 1987, where it is 50.02% above its
156-week MA measure of known valuation.
This amount of over-valuation lead to sideways to down price
action for about 14 years to lows of $3.51 on the week of 18
February 1991, $3.57 on the week of 15 February 1993, and $4.04
on the week of 19 November 2001. From there a 4.5-year rally has
pushed prises to $12.97; 87.46% above its 156-week MA, last week!
One could easily argue that over valuations of 50%, or less,
have contained all rallys for the last 25 years, and lead to
prices moving back to, and below the 156-week MA, which
currently stands at $6.92, so the next major move should be
towards this level, and probably substantially below that! The
only thing that makes this far less than 100% certain is the
fact that over-valuations can always extend further than this in
both price, and time, as witnessed in 1980! However, the odds
greatly favor a large price drop more than a large rally!
Since the and silver markets are flashing basically the
same message, anyone who believes in the concept of
over-valuation should consider liquidating their and silver
holdings. Aggressive traders might even take short positions or
buy an inverse mutual fund like SPPIX that moves opposite to the
action in and silver stocks.
In addition, residential real estate appears to be in an
unprecedented bubble, based on measures of known valuation, and
due for a very large move to the downside. Such a move should
cause a major credit collapse, which would unleash a
deflationary wave that would exert tremendous downward pressure
on and silver prices.
ternational financial problems are often brutally reflected in our everyday economy. Gold coins are almost immune to such incidents, as they have been for centuries. Even if many people associate bullion with pirate stories or fairytales, the fact is that investing in coins can make the difference between a smart and a risky financial position.
David Stanowski is the owner and publisher of
http://www.TheFinancialHelpCenter.com, a web site with coverage
of and commentary on the financial and investment markets.
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