Rising Gold and Silver: Essential to Any Investment Strategy

by: Jonathan Cavuoto October 06, 2008 | about stocks: GLD / QQQQ / SPY    

Jonathan Cavuoto

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Political Economy dominated the financial markets last week. The failed first attempt for Congress to pass the Financial Bailout package on Monday sent the Dow Jones Average down 778 points, a loss of 7%. The S&P 500 and tech-dominated NASDAQ fared even worse, each dropping 9% on Monday. Gold shot up from a $739 low to a $932 peak.

Stocks recovered a bit on Tuesday, and precious metals experienced profit taking (a trading opportunity many precious metals investors had been waiting for). By Friday, both the Senate and the House of Representatives enacted legislation that was renamed a more politically correct Financial Rescue package, nevertheless, the Dow remained down 7% for the week (closing at 10326), the S&P 500 was off 9%, and NASDAQ was down 11%. Spot Gold Bullion fell 6% for the week, closing at $831.

click to enlarge

The lockstep moves between stock market indexes and the price of oil seems to have abated. During the summer, almost without exception, if oil prices increased, stocks fell, and if oil declined on the world’s markets, stocks advanced. Gold and silver were stuck in a trading range. With the looming financial crisis, these patterns changed.

Looking ahead, Carlos Sanchez, a precious metals analyst at CPM Group, says that if the rescue plan works, and supports the US recovery and the US dollar, it could make for declines in gold and silver but adds “any effect of this nature is at least six months out.”

Mr. Sanchez said:

During that time, there will be continued uncertainty about whether the plan is improving the economy leaving precious metals to remain supported on safe-haven flows.

Mr. Sanchez is not alone. A Merrill Lynch research note that was circulated last week wrote:

Once the immediate liquidity crisis subsides, the market should focus on the fiscal implications of the recent (legislative) measures, putting heavy downward pressure on the US dollar. A weaker US dollar should help support gold prices, as the two markets have been closely linked in the past year.

In the September 15th edition of the Cavuoto Report we provided two links to historical prices for gold and silver. Here they are again, to do your own research for gold and for silver.

There are three very practical reasons for street-savvy investors to prefer silver over gold as a precious metals investment at this time. First, silver has all the monetary properties of gold, yet appears to represent substantially better investment value. For example, gold-to-silver price ratio has historically been 10:1.

Based upon Friday’s closing prices for open contracts, this ratio is currently 74-to-1…($833.20 divided by $11.33, see table above). If that ratio moved halfway to its historic average (say, a ratio of 35), this would imply an equilibrium silver price of $23 an ounce, which incidentally is about where silver was, just prior to Bear Stearns being married off to JP MorganChase (JPM), a marriage engineered by the US Government.

Second, for the past decade, silver’s supply and demand worldwide has been in balance. Surplus inventory is a non-factor and the international politics of precious metals reserves is always the domain of gold, not silver. And finally, on fundamentals, over 20% of silver production now goes into high tech products (a demand factor non-existent in the past) and used in such small quantities that even a doubling in price does not affect demand, as confirmed through last March, when a 12-month rise in the price of silver from $9 to $20 did not affect industrial demand.

As Alvin Toffler said in Future Shock:

Western society for the past 300 years has been caught up in a fire storm of change. This storm, far from abating, now appears to be gathering force. The inability to speak with precision and certainty about the future is no excuse for silence. Where hard data is lacking, the responsible investor/analyst has an obligation to rely on other kinds of evidence…including anecdotal data and the opinions of well-informed people.

We’ve shared two of these opinions above (Mr. Sanchez and Merrill Lynch). In addition, there is this fact - rising precious metals prices are always a thorn in the side of a government. By its very nature, rising precious metals prices implies inflation and a flight from currency risk, implications that are hard to dismiss in the public arena.

So let’s look at some practical financial facts:

The dollar value of gold and silver futures contracts written last week approximated less than $90 billion. The dollar value of purchases of stock in the three largest public companies in the world - ExxonMobil (XOM), GE (GE), Microsoft (MSFT)  totaled $46 billion, just three stocks, and there are over 11,000 stocks traded.

Our point is that relative to other capital markets, it would not take that much capital to artificially dampen pricing in the gold and silver markets. After the election and before year-end, it is plausible to expect precious metals prices to bounce upward by 20% - 25% with gold reaching $1,000 to $1,200 and silver trading between $15 and $20 per share.

In preparation for the changes ahead, as we have said often in prior weekly letters, if an individual investor’s portfolio strategy does not include physical ownership of gold and silver, then it is an incomplete investment strategy.

Disclosure: None

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This article has 13 comments:

  •  
    Oct 06 09:30 AM
    Well said! Silver IS the metal to buy and take physical ownership (in preference to Gold) however, one should not be devoid of gold either.

    The BIG question is what will be the FIRST digit in THREE digit silver, and what will it be in FOUR digit gold? Both questions very well could be answered BEFORE 4th quarter ends! Good hunting!
    Reply | Link to Comment
  •  
    Oct 06 09:33 AM
    I would definitely load-up on gold and silver before Obama gets in office and gives even more taxpayer dollars away to the "community".
    Reply | Link to Comment
  •  
    Oct 06 10:18 AM
    Silver for sure; gold for certain.
    Reply | Link to Comment
  •  
    Oct 06 10:24 AM
    Effectively Sanchez is saying that gold will profit from uncertainty near term and up to about six months out. By that time he implies that a successful resolution of the credit trap would improve the economy and gold would fall. But even the eventuation of a severe world wide recession would also cause gold to fall at some point in time. So I think one may want to increase on gold short term but not as a total replacement for productive (interest, dividends, capital gains) investments.

    Reply | Link to Comment
  •  
    Oct 06 11:49 AM
    Does anybody know if Kitco is a reputable broker?
    Thanks
    D
    valuestockinvestors.bl...
    Reply | Link to Comment
  •  
    Oct 06 01:05 PM
    It's just amazing how the market is getting spanked yet silver remains strong.
    Reply | Link to Comment
  •  
    Oct 06 03:48 PM
    Kitco is DEFINITELY NOT WHERE YOU WANT TO SHOP...if you want to receive your merchandise!

    Try TULVING.
    Reply | Link to Comment
  •  
    Oct 06 06:31 PM
    Agree with 30121,

    Kitco's website rocks (if I could only avoid clicking on Nadler's articles), but it really looks to me that they've sold stuff that they didn't have, and now they can't get it at all.

    Of course, this would explain Nad's "sell your gold and silver, before it's too late!" articles.

    Use the sight, buy elsewhere. I've used Monex, and I'd be curious to hear what others think of think of their dealers.
    Reply | Link to Comment
  •  
    Oct 06 06:58 PM
    What is the best way to buy silver coins, with a reasonable premium?
    Reply | Link to Comment
  •  
    Oct 06 07:27 PM
    To: mlonz:

    Engelhard or Johnson Matthey are the best. Your premium is less than Silver Eagles, which many "experts" avoid like the plague because of the premiums and that they are overhyped.

    Good luck!
    Reply | Link to Comment
  •  
    Oct 07 12:35 AM
    APMEX.com is a good site for buying all precious metals and even collectible coins. They DO NOT sell what they do not have in stock, so the pickings might be limited from time to time but you will get what you buy (at least I have) within a week or so. Their premiums are reasonable with cash payments but they do add an approx 3% credit card fee if you pay that way, which is still cheaper and safer than eBay. If they do not have what you want in stock just keep checking back because they keep their site very well updated.
    Reply | Link to Comment
  •  
    Oct 07 11:31 AM
    I'm definitely thinking silver bullion, but what about silver mining stocks? Aren't there silver mines in Mexico that have recently shown much silver to be mined?
    Reply | Link to Comment
  •  
    Oct 08 12:50 AM
    275515,

    I think the price of silver has to move first, because silver mining stocks are still stocks (and if there's one everyone hates right now...).

    When silver starts making big moves, the miners should follow, if we've still got a market.
    Reply | Link to Comment
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