Silver Is Not Normal

Well, the price of silver is up, it's down, and it's back up again. We have record-breaking volatility and record-breaking single-day price moves, and it has a lot of investors worried. But that worry comes from using the wrong mental models. So in this video, I'm going to explain why the normal way of thinking about these prices is wrong and how volatility is actually exactly what you want. So let me start quickly with three examples of the type of content I'm seeing that has investors worried. First time in history, the system has completely broken. The probability of what's happening is near zero. Three sigma-6 moves in one week bonds silver. Gold, we are living through a statistical impossibility. Okay, so by the way, this was just a couple days ago, and gold and silver prices are already rebounding very nicely today. But there still is a lot of volatility, and the volatility is going to continue. That's why we're doing this video. Gold and silver black swan, gold down 15%, silver down 38%. We just witnessed the first sigma-10 event in financial history. Mathematically, this shouldn't happen. In the lifetime of the entire universe, the simulation is literally breaking. Okay, and finally, this came from a blog post that someone sent to me. A statistical impossibility, a 10-sigma event in silver, an 8-sigma event in gold. These are events that, according to standard financial models, should never happen in the lifetime of the universe, let alone in the same week. Okay, I wouldn't blame anybody for seeing something like this and thinking, the models are broken, the models are wrong, the silver bull run is over, everything's falling apart. I wouldn't blame you for thinking that. However, there's an interesting caveat, according to standard financial models, right? According to standard financial models, this should never happen. Well, okay. So, if it seems like reality is broken or your models are broken, which is more likely? Your models are broken. So, why are the models broken? Well, let's take a look. A normal distribution looks like this, the blue curve here, and you'll notice it's symmetrical left and right. And basically, you're more likely to get average events and you're very unlikely to get extreme events, extremely high or extremely low. So, in the case of silver, if it followed a normal distribution, you'd be very unlikely to get really high one-day returns, positive or negative. However, silver is not normal. It does not follow a normal distribution. It does have a bell curve of returns, that's what we see here, but it's not normal. So, the gray is what silver actually does. So, these are all of silver's daily returns since 1970, all of them. So, I made a little histogram here, and you can see that events around average are slightly more likely to happen. That's not very exciting. But then, as we get further out into two or three standard deviation events, positive or negative, silver is less likely to have those events. However, when it gets fascinating is when we zoom in on the tails, the four, five, six standard deviation events. So, let's do that. We zoom in here by a factor of 10. We're focused on the bottom. We see that as we start getting to the tails, there's a higher probability of those tail events happening compared to what a normal model would predict. Let's zoom in even further. This is our final level of zoom here, and you can see that there's a very big difference between the blue line and the gray line. And so, what we see is that silver on the negative and positive side has these really extreme events, six sigma or higher. I lumped them all in at the end here, six sigma or higher. They happen about one in a thousand trading days or one and a half times in a thousand trading days, whereas the blue line predicts that they should be very close to zero. So small, in fact, that we really can't zoom in far enough to see it this way, so I'm going to present it differently. So, how common is a six sigma or greater trading day, positive or negative? Combine them. In a normal distribution, that happens one out of every 500 million days, which is once every two million years. Okay, so probably you wouldn't live to see it. But silver, based on what it actually has done empirically, it happens one every 407 days, which is once every 19 months. So it's actually pretty common. You're going to see a lot of them throughout your investing career. Silver experiences extreme up and down days a million times more often than normal models predict, a million times more often. Okay, and that's not my model compared to a normal model. That's actual reality compared to a normal model. Okay, so I'm not cherry picking a certain model here. I'm not biased to try to do one thing or another. That's just what silver has done empirically. And as I said a moment ago, gold and silver prices are already recovering. So this is earlier today, gold prices extend gains to 7% on the day and silver prices extend gains to 13% on the day. And the day is not even over, not even halfway through. So gold is back over 49.50, silver above 87. And a really common reply to this is what is here below this tweet. I'd prefer to stay well away from this. This doesn't look much like normal market pricing and volatility. Exactly. This isn't normal. It's not a normal distribution of returns, but it is normal in the sense that it's what silver and gold and other financial assets do during repricing events. So let's actually look at the different regimes that these assets have. So what I have here is the price of silver as well as the Z score of each return. So how many standard deviations away from average each daily return is. So the price of silver in the gray line and all the blue dots are those Z scores. So this goes back to 1979 or includes the year of 1979. And you can see all the Z scores, all the blue dots are clustered around zero. They hover around zero, which is fairly normal. That's what you would expect. But then when silver reprices, all those blue dots spread apart. And so they don't bunch up around zero. Look at all these gaps, all these white spaces that aren't filled with blue dots. So we're not really getting normal returns in that range. We're getting abnormal returns, very high Z scores. So a Z score of almost positive 20. And there's some negative ones, negative eight, negative nine. And so if we use the normal financial model, a normal one, we would expect that this happens one every 2 billion years or whatever. And look how often it's happening. There's so many of these dots because it doesn't follow a normal distribution when it's repricing. It operates by different rules. Then it hovers around zero again and then it reprices and we get that expansion of all those Z scores. Not many clustered around zero, but they're extreme. They're 8, 10, 12 standard deviations away from the mean. So that's what happened towards the end of the bull run there. That's what happens when silver reprices. That's what happens when gold reprices. This type of thing happens with all different asset classes. And so if you're stuck using a normal distribution and you see one big day of volatility, you're going to freak out because you don't understand that volatility is actually a good thing. It's a sign that your investing thesis is playing out. So if you had a thesis like, oh, silver is actually worth a lot more. And if you understood that, well, in order to get there, we have to have a lot of volatility on the way up. Then you could very comfortably ride this out. But if you thought that volatility was a sign that your thesis was wrong and invalidated, you would panic sell and you wouldn't enjoy those massive gains. So the volatility here is actually a good thing. Fast forward to today, we see the exact same thing happening. A lot of Z scores, a lot of daily returns clustered around the mean hovering around zero. And as that silver price goes up, we start to see a spread in those returns. It just so happens we got a really big down day before a really big up day. But that doesn't invalidate the thesis. Those of us who are long silver, and there are many of us watching who are, we want the price to go up. But in order for it to reprice by multiples, 3x, 4x, 5x, maybe 10x. In order for that to happen, there has to be a lot of volatility along the way. It's the only way that it can get there. So I expect that, yeah, there may be a clustering around zero for a time. But in general, there's going to be a lot of volatility in the short term and a lot of volatility during any massive move up. So if you shouldn't get caught up in the day-to-day price action, and you shouldn't, then what should you pay attention to? What actually matters for silver? Well, we talked about this in a previous video, five trends. The first is the structural deficit. Second, sovereign demand and control. Third, backwardation. Fourth, loose monetary policy. And fifth, volatility. So did any of these five things change in the last few days? No, absolutely not. And in fact, the presence of volatility supports the repricing theory. If volatility completely disappeared and we had completely normal returns, that actually might be a step that says, you know what, maybe silver isn't going to get repriced right now. So the presence of volatility is actually a good thing. Investors who understand that volatility is a part of the game can actually use these corrections as buying opportunities, not a reason to panic sell. I want to end here with our meme of the day. There's a 0.0001% chance of my house burning down on a given day. This is fine. Thanks for watching.