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Sunday, December 12, 2010

The Out-performance of Silver and Asset Bubbles

 So, from the above chart you can see that the silver ETF (SLV) has recently had a huge run, far outperforming the gold ETF (GLD). Some have wondered why this is, but it's really no great mystery. As you can see, silver's movements are directionally the same as gold's, but are just much more exaggerated in the last three months. Arguably, they are both part of the same play as a hedge against dollar devaluation, inflation, financial instability and so on so why the disparate performance the favors arguably the less intrinsically valuable asset?

It's much the same reason in the late 1990s that the more detached a stock was from its fundamentals, the better. Just off the top of your head, if I asked you which stock would perform better in a huge bull market, a stock with a well established earnings history and reasonably reliable forward earnings projections or a fly by night enterprise with extraordinarily speculative earnings prospects, you would probably choose the former. However, that's not what happens. Instead, when the wind is at their backs in a particular asset class investors turn to the more speculative members of that asset class. Take GE (GE), Cisco (CSCO), JDS Uniphase (JDSU) and Microstrategy (MSTR) in the window of December 1998 through March of 2000. All of these stocks did well and all became quite overvalued, though to far differing degrees.

You can barely see GE's advance there, Cisco returned a very respectable 200% and the other two went nuts with JDSU setting the pace. The last three were all part of the same general play, which was speculation on the growth rate in technology company earnings, while GE was part of the broader bubble in stocks. In order, GE's earnings were the most stable and well known, followed by Cisco, followed by Microstrategy, followed by JDSU. In the earlier days of the bubble, the margin of out-performance of the two trashy stocks was not as large, but it really took off about September-October 1999.

In other words, the trashier the better when a bubble occurs and that would seem to indicate that the surge in silver might be a signal that we are at the apex of a precious metals bubble.

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