SELECTING A MARKET TO TEST
4. SELECTING A MARKET TO TEST
Now, we’re finally ready to take our generalised principles, which appear promising across a range of market types, and use them to build actual models for a specific market. Then we can test real holdout performance and see how it compares with our ‘buy and hold’ benchmark. As you’ll see in the ‘About’ section, this project began with the purpose of discovering whether it was possible to beat the Gold and Silver markets. Therefore, I wanted to select one of these two markets in order to build the complete Proof of Concept. Let’s take a closer look at Gold and Silver’s performance, compared with each other over the past 25 years. The following chart shows the percentage gains of each, with Gold in red and Silver in blue.
It’s clear that the Gold and Silver markets are correlated, but Silver exhibits substantially more volatility. It tends to make big gains and big losses much more quickly than Gold. In 2011, silver shot up to almost $50, while Gold’s relative ascent was much steadier. The chart also shows how in Gold’s extended sideways period from 2013-2019, silver declined while gold remained relatively steady. This volatility, both upwards and downwards, is clearly demonstrated in the following graphic which highlights two of the biggest periods of profit and loss in the Silver market over the past 50 years. Silver tends to have less of a ‘safe haven’ quality compared with gold which certainly leads to greater losses during periods of decline. For a ‘buy and hold’ investor, epic gains of 493% and 886% would have been wonderful, and numerous other profitable periods would have been experienced as well. However, our ‘buy and hold’ investor would have had to stomach many substantial losing periods along the way, including the two highlighted of 78% and 77%, making it a very rough journey.
ABOVE GROUND SUPPLY: GOLD VS SILVER
Another factor that differentiates the two markets is the total above-ground supply. For gold, this is vastly larger than for Silver. While gold has around 6.4 billion ounces in above-ground stock, silver's supply is much smaller at around 2.5 to 3 billion ounces.
Gold’s large above-ground supply and its role as a store of value also contribute to its stability in the market. In contrast, silver's smaller above-ground supply and significant industrial use lead to more price volatility and a different market dynamic.
Despite silver’s larger annual production, the above-ground supply of gold is far more valuable due to gold's higher price per ounce and the fact that nearly all the gold ever mined is still in existence.
PICKING A SINGLE MARKET
Taking all of this into account, it’s obvious that Silver would make a much harder market to trade successfully. It’s profitability in bullish periods is immense, but the general volatility and losing periods can be extreme.
For this project to successfully pass the Proof of Concept test, it will need to be substantially more profitable over an extended time period than our benchmark performance, and also exhibit less volatility.
For this reason, I chose Silver as the market for the full Proof of Concept, as I believe it is a much harder test, and if our methodology proves capable of beating the Silver market over more than 50 years, then it can probably beat any market.