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Silver: The Monte Carlo Effect and Speculative Man

  1. yttrium

    3,816 posts.
    A most bizarre set of events occurred at the roulette wheel in the casino at Monte Carlo on August 18, 1913. It started innocently enough with the wheel stopping on black. And then it stopped on the black again, and then again. With each spin of the wheel the interest of the patrons was further aroused. Black again, then still black! At about the fifteenth successive black began an almost hysterical rush to bet on the red. Patrons doubled and tripled their bets, reasoning that a change in the status quo must surely be due. The wheel stopped on black twenty-six times in succession and the casino made millions. What was up till then known as the gambler's fallacy has since become known as the Monte Carlo fallacy, after this famous event. Of course, the patrons were mistaken in thinking a red number more likely after so many successive blacks, as the spinning of a roulette wheel is both an independent and random event.

    Speculative manias can follow a similar pattern. "dot.con" gives a superb description of the life and death of a speculative bubble. The incredible tech boom of the last five years of the twentieth century had its beginnings with an incorrect assumption by economists. This assumption was that new technologies would contribute greatly to productivity, allowing a much faster growth rate. But from the 1970s to the 1990s technology had delivered very little in the way of productivity gains. This paradox was considered to be due to the fact that while new technologies were rapidly developing, the full benefits would not be realised until they were properly integrated with the existing economy. It was also believed that when this integration started there would a rapid phase of catch-up growth, and that the growth would centre around companies that went headlong into change.

    By the early 1990s the idea that the internet would be the avenue for change was gaining favour. With the IPO of Netscape in 1995 the mania started. The Wall Street spruikers certainly had a polished story, and the small amount of stock released meant that even a small demand would drive the price higher. This formula was repeated ever more frequently over the next few years, and the almost guaranteed profits for investors whipped the market into an even greater frenzy. The apparently insane valuations given to dotcoms, as they became known, were justified by the incredible growth they would experience later. The status quo of loss making was about to change. These companies represented a turning point for the economy, and would herald a period of growing prosperity unequalled in history. The bearish analysts faded into obscurity, confounded by the market's insanity, while the bullish ones became celebrities. The Wall Street firms loved the hype, and made more from the dotcom IPOs than they did from their dealings with bluechips.

    Then things turned nasty. The dotcoms were eating money faster than ever, and profitability was becoming increasingly reduced and remote; the reality was far different from the hype. People were becoming reluctant to invest more money. The amount of available stock had also ballooned, greatly changing supply/demand fundamentals. The house of cards collapsed, and the ruins are still crumbling away today, leaving a plethora of dudded investors.

    The behaviour of the silver market over the last decade has been bizarre. Despite a continued deficit of supply the silver price has stayed low. There are rumours that the price has been kept artificially low by the use of derivatives. This practice may have started in the early to mid 1980's, perhaps intensifying when the potential threat of digital photography to the silver market, in the form of a permanent silver surplus, was considered to be very likely. Thus it may have represented attempt to desert an apparently doomed ship before many of the passengers realised what was happening; a form of queue jumping if you like.

    But the status quo is not changing; the silver deficit continues. And unlike a roulette game, the deficit is supported by robust demand, not chance. More and more silver is dumped on the market, yet the permanent silver surplus assumption looks increasingly unlikely. In fact, the continuing deficit could have a Monte Carlo effect of its own.

    I believe that silver and possibly gold -I am less bullish for gold, although I believe that its price may have been manipulated by the same derivatives inspired scheme as the silver price may have been- are at about the fifteenth successive black stage of their speculative bubbles. But unlike a roulette wheel, the current interest in silver has a logical grounding. The continuing silver deficit is starting to attract more attention, and the arguments of the bears are becoming increasingly unfeasible; if this attention results in more investment in physical silver and the discrediting of silver derivatives as an speculative tool, then the run may start sooner. My own preference is for silver, even though it lacks the prestige of gold. I base this preference on the following well known reasons:

    The ongoing decline in silver stocks is not driven by speculation: In Silver Statistics, by Kenneth E. Porter and Henry E. Hilliard -available from the USGS website- visible silver stocks have apparently declined from about 91,000t in 1939 to about 4,400t in 1998. Even without a speculative bubble, a finite silver inventory cannot cover the deficit indefinitely. In contrast, most gold mined is still in a readily available form. From reading the work of the gold bugs, the main hope for gold is its re-establishment as the ultimate form of money following a world-wide fiscal crisis. A substantial rise in the silver price would require no such event; it would in fact occur faster in the event of a recovery, as this would further increase demand.
    There is currently about twice as much available gold -two billion oz- as silver -one billion oz-: Although four oz of silver and eight oz of gold per US citizen makes both metals pretty rare, the cost to buy the gold is 2600 USD per US citizen c/f 20 USD per US citizen for silver. If the available gold tripled in value it would be worth close to two trillion USD; if available silver increased thirty fold, it would be worth about 150 million USD. The implication is that because available silver is 1/130th the value of available gold, its price may be driven proportionally higher by a speculative mania.

    The wait has been a long one for the gold and silver bulls, with many false starts, and it has taken a heavy toll on some. Charles Savoie for example, whose entertaining work appears on Mr Morgan's website, would have to rate a bold entry in the seriously nuts column of the sanity journal IMHO. If this guy is anything like I imagine him, then I believe that he would be more convincing to potential silver investors by doing something about his wild eyes and foaming mouth. From reading his work, I don't think that he has convinced anyone that he has spoken to!

    I certainly share the frustration of Hotcopperites like Woddonnee. I think of the silver situation as a water tank with the tap on, and a fat man standing next to it taking bets on when the water will run out. Buying derivatives is like having a bet with the fat man. People are eagerly placing bets with him, reasoning that the water must surely run out soon. But guessing without having a look in is a mug's game, and nobody gets a look in, except perhaps the fat man himself. If the likes of Mr Butler, a man who has lived the silver market for the last 20 years, can only be as definite as saying that available silver will run out soon, then I figure that a dumbhead like me should not even try to guess. However, if my analogy is correct, then owning physical silver is like filling a bottle from the tank; the tank will run out sooner and then things will get thirsty. Placing bets with the fat man wont make the water run out any faster.

    Speculative manias have their day, then sanity returns and an equilibrium is restored. The silver speculation is just starting.

    Don't bet with the fat man!



    All about silver

    The Silver Institute : http://www.silverinstitute.org/newsdesk.html
    GFMS : http://www.gfms.co.uk/html/f_silver.htm
    CPM Group : http://www.cpmgroup.com/
    Silver User's Association : http://www.silverusersassociation.org/
    USGS Minerals Information Silver : http://minerals.usgs.gov/minerals/pubs/commodity/silver

    The silver gurus

    Ted Butler : http://www.butlerresearch.com/
    David Morgan : http://www.silver-investor.com/

    A derivatives CT

    Adam Hamilton : http://www.gold-eagle.com/research/hamiltonndx.html

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