By Georg Vrba
Gold has declined substantially and many commentators believe that the price will go much lower. But will it? The chart below shows the price of gold plotted on a semi-log scale from 1968 to 2013, and the year-on-year percentage change of the price expressed in standard deviation terms for a rolling 10-year sample period. What strikes one is that the recent decline is not particularly spectacular in comparison to previous declines, and that the year-over-year percentage change of the price is now minus 2.67 standard deviations (sigma) away from the mean, the lowest that it ever got.
The population within a deviation of 2.67 sigma, using excel functions, is p = ERF(2.67/SQRT(2)) = 0.992415. Thus the population within the one outer extreme of the normal distribution curve is (1-p)/2 = 0.38% of the total population. So if you are betting on a further decline of the deviation (and gold price), then your chance of winning is 1/0.38%, or 1:263. Good luck to you.
It is also evident from the chart that whenever the year-over-year percentage price change reached a level near minus 2 sigma, then invariably gold began an upward move fairly soon thereafter. A bounce of the gold price is now overdue.
The current state of affairs calls to mind the first three of Bob Farrell's rules:
- Markets tend to return to the mean over time.
- Excesses in one direction will lead to an opposite excess in the other direction.
- There are no new eras -- excesses are never permanent.