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As a result
of active "demonetization" efforts by the IMF and its member central
banks, gold and silver have experienced the type of volatility that has given
conservative investors reasons not to perceive the metals as dependable cash
alternatives. Instead gold and silver have become known as the asset class to
hold as a hedge against inflation.
However,
during the 1990's, when inflation was in general much higher than it has been
since the turn of the millennium, gold and silver prices drifted lower and
stagnated. However, since 2000, gold and silver have risen by over 400 and
700 percent respectively. Remarkably, this has occurred over a time frame
during which, by most accounts, low inflation has prevailed. How can this be
explained?
In 1944 when
the U.S. dollar was considered 'as good as gold,' it was made the
international reserve currency. This unique status is the reason that Fed
Chairman Ben Bernanke was recently able to say that, "The U.S.
Government has a technology, called the printing press that allows it to
produce as many dollars at it wishes at essentially no cost."
Today, with
the Federal Reserve treating the greenback as a never ending lottery ticket
for deficit spending politicians, many investors feel the U.S. dollar is good
for nothing. As a result there is an increasing international pressure to
remove the U.S. dollar's reserve status. Given that there is no widely
accepted alternative to the dollar (the euro has many problems of its own),
this is creating fears of an international currency crisis, which has fueled
interest in precious metals. So metal prices have risen even with low
inflation expectations.
In order to
paper over the effects of the financial collapse, central banks around the
world are printing as fast as their presses can manage. But unlike prior
periods of monetary inflation (like the 1970's), some major powers (China)
are withdrawing liquidity. In addition, emerging market manufacturers are
holding down prices even as currencies lose value. This may explain the
strong performance of metals despite seemingly manageable inflation. But if
higher prices emerge into the light of day (as they already have in
commodities), currency uncertainty combined with high inflation should
intensify the market for precious metals. The question then becomes how to
play the market.
Gold has
always been the reserve asset of choice for central banks and major private
investors. But now, as smaller investors become aware that paper dollars are
under threat, many are looking towards silver. Taken in aggregate, these
smaller investors have enormous buying power. Through ETF's and mining stocks
they are not bound by government restrictions on holding precious metals in
retirement funds. In contrast to gold, central banks do not hold much silver.
They are therefore less able to push down the price of silver by dumping inventory
when rising metal prices undermine currency confidence.
Indeed, so
far this year, silver is up nearly 50% while gold is up only about 6%. Given
these figures, investors may be forgiven if they feel that the big move in
silver may be over. Technical analysis may provide comfort.
According to
the U.S. geological survey silver is about 17.5 times more abundant than gold
in the earth's crust. This ratio has long been appreciated by civilizations
throughout history. Thus, in 1792 the newly formed U.S. Congress passed the
First Coinage Act, which legally set the valuation ratio of gold/silver at 15
(it was raised to 16 in 1834). In the early 1990's, with silver out of favor
with investors, the ratio approached 100. At the beginning of this century
gold stood at some $250 an ounce and silver at $4, putting the ratio at about
62. Today, with gold at around $1,500 an ounce and silver at $45, the ratio
has closed to around 33. But this is still far higher than the ratio seen in
the late 1980's (silver's last mega spike), and if far higher than the
natural proportions of gold and silver would suggest.
The demand
for physical silver also remains strong, which supports the market for spot
silver. Smaller investors may find gold too expensive at $1,461 an ounce, but
may be nevertheless prepared to buy several ounces of silver for much less.
Potentially, this 'poor man's gold' market may help drive silver prices far
faster than gold.
John Browne
Senior Market Strategist
Euro Pacific Capital, Inc.
20271 Acacia Street, #200 Newport Beach, CA 92660
Toll-free: 888-377-3722 / Direct: 203-972-9300 Fax:
949-863-7100
www.europac.net
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