Moriarty opines that relationships exist between both similar and dissimilar commodities. The ratio of the number of ounces of silver it takes to buy one ounce of gold varied from about 17 to 1 in January of 1980 to over 100 to 1 in early 1991. We view both metals as precious and having some aspects of money. But the ratio changes a lot and that creates an opportunity to profit without needing the ability to predict direction of price movement. You do not need to speculate on the commodities going up or down, only that they regress to a mean.
And it is not necessary for commodities to be similar. For some reason sugar and silver seem to move together much of the time. There is no necessity for a logical relationship in order for there to be an actual relationship.
To understand deviation from the mean, we first need some basic understanding of what makes prices change. That is easy. The answer is inflation. But inflation distorts price information and while eventually everything goes up because of inflation, things go up at different rates because the market does not know at any given time what the correct price is for anything and is constantly testing.
For each pair of commodities that we might seek to profit from there will be a different chart, but basically it is all about deviation from the mean of inflation and regression to the mean.
Going back over the past 100 years, if we chose to use silver vs. gold as our means of investing for a profit, the ratio has varied from 17 to 1 to 100 to 1 but had a mean of 53 to 1. Do remember that the price of gold was fixed at $20.67 an ounce until Roosevelt took the public off the gold standard in 1933 and revalued gold at $35 in January of 1934. While the price of silver varied between 1934 and 1971, gold remained relatively constant until Nixon took us totally off the gold standard in August of 1971. Since that time both metals have traded freely and have offered numerous opportunities to profit.
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