Precious metals: The forecasting problem
“The problem is not that there are problems. The problem is expecting otherwise and thinking that having problems is a problem.”
- Theodore Rubin
The media sensation surrounding various storms of the century has been astounding. Meteorological prediction is complex science to say the least. The fact that 24 hour forecasts have become almost 87% accurate over the years is a testament to modern science – and, in particular, chaos theory.
However, the ability to predict large and rare events like big storms, tornadoes, hurricanes, and blizzards, is extremely difficult because these storms ultimately manifest based on an array of very statistically small probabilities - too small for mathematical prediction and, therefore, reliable modeling. Of course, that never stops the media and its incessant need to churn attention and traffic.
This got me thinking about how to forecast asset prices or simply economic-financial outcomes with any sort of precision. Obviously, much sensation surrounds and fuels this phenomenon in every industry. We are not immune.
Precious metals prices have been teetering on the edge of extreme fragility for years. In fact, it's been so long that we, as current observers, are almost completely insensitive to the basic conditions – or the conditions surrounding price discovery.
Even those of us who have taken the time to understand the who, how, and why of manipulation are not immune to the thrill of forecast and trading. This idea that price is connected to a sustainable reality is pervasive and rooted in our psychology. I believe it also leaves us severely vulnerable to surprise.
Sensitivity to Initial Conditions
Small variations in any system aggregate and amplify over time. This is part of the crux of systems and chaos theory.
It's where we get the overplayed euphemism, "When a butterfly flaps one wing in China, a hurricane is born off the coast of Africa...”
It gets even better than that.
In the book, "Chances Are...Adventures in Probability" by Michael and Ellen Kaplan, the authors point to the work of physicist David Ruelle, a chaos theory expert who demonstrated that:
"…suspending the gravitational effect on our atmosphere of one electron at the limit of the observable universe would take no more than two weeks to make a difference on the Earth's weather - equivalent to having rain rather than sun at a picnic".
One electron, one snowflake.
But tiny variables are unnecessary when it comes to financial systems - especially those systems that are controlled with aggression and longevity.
Take precious metals - particularly silver. Because its price discovery mechanism is so extremely corrupt, it is easy to imaging the eventual accident waiting to happen – along with the variety of scenarios that might serve as a trigger (We discuss these almost constantly, though we cannot pinpoint the timing).
Apply this to supply and demand fundamentals and you have some semblance of price based on the fluctuations in reality; not necessarily easy to predict, but rational nonetheless.
We have a market (markets) long-divorced from any semblance of real fundamentals. And that makes the next significant move even less predictable – practically guaranteeing that it will detach far from expectations, completely catching observers off guard and very likely spilling over to tilt all markets, near and far.