All that Glitters is not Gold

CNBC had the following commentary:

Silver looks attractive to Graham Bibby, managing director at Richmond Asset Management, as he believes it is slightly undervalued. He explains his investment rationale for this precious metal, as well as gold.

I agree with all of this, except “slightly” undervalued. Silver is at historical lows relative to gold, and the situation has changed in significant ways in the last few years such that I strongly believe that the short-term volatility in the precious metal is advantageous to people looking to eke out a small profit **in these difficult times. Why? Contrary to popular belief, silver is more rare than gold**. Sound crazy? It’s not—I’ll come back to that.

**Why gold? **Gold has always been the traditional “safe haven” investment/hedge. Why is that?

Well, it’s pretty and shiny (doesn’t tarnish) and extremely malleable (can be worked better than any other metal with simple tools) and is useful in electronics because it is highly conductive. I’m oversimplifying here, but that first value is still of use (though palladium and platinum share this characteristic), but modern manufacturing techniques and synthetic materials science have drastically reduced the value of the second. The third is actually BETTER in platinum.

The real reason is historical context—gold has been the basis of money since before the Pyramids were “under construction.”

It’s only the last few decades that the world financial systems were based on currencies not directly backed by gold reserves (or indirectly by being tied to the dollar during the gold standard as per theBretton Woods accord.) This is partially for the reasons above, but also (as a relative of mine is keen to point out) because it is near impossible to counterfeit. Still, though, just because something was used historically as the symbol and backing of currency doesn’t mean it will continue. The Romans even used Salt as currency for a time.

I hold Gold as a hedge against inflation, not as an investment– I do think it will increase in value in the case of inflation (and/or hyperinflation.) However, I hold stocks and other investments as a hedge against the poop not hitting the propeller from that particular direction. Despite everything the Fed and Treasury are doing to increase the money supply, there are strong short and medium term deflationary pressures. I believe diversity is the way to go unless you are absolutely certain of what’s coming… and as I discussed in my recent “Markets and Chaos Theory” post, nobody really knows what’s coming.

I started my silver position(s) when it dropped below 10 a few months ago, having dropped from the 20s. I think it will see the 20s again. If you can handle the swings, I think it’s a great opportunity—but beware. It’s more volatile than gold (and that’s saying a lot.)

In most locales, physical silver is extremely hard to get ahold of at prices aproaching “spot price.” This may indicate additional risk in non-physical silver instruments such as the SLV Exchange Traded Fund, and COMEX contracts. I may address this in a future post.

**Just how rare is gold? **Back to the rarity of gold vs. silver: There are several issues that impact the supply/demand equation, I’ll just list two:

  1. Over 90% of the gold that has ever been mined in the history of civilization is estimated to still be in circulation. By way of comparison, the majority of silver and platinum is in a landfill somewhere. This means the gold supply continually increases-- there's no material consumption, but we’re continually mining and increasing supply.
  2. Governments and central banks used to maintain and grow massive gold reserves, especially back in the days of the gold standard. With this no longer being the case, there is much more gold "in circulation" than there used to be, and the largest consumers are no longer in the market (and are divesting themselves over time-- whether for intentional manipulation or just to get rid of the asset is up for debate.) This reduces demand. It will take time for the market to adapt to this change-- it's happened slowly over the last few decades, but I don't think we're done yet. The lion's share of gold is in the hands of private investors.

By way of comparison, **silver is currently being consumed faster than it is being mined. **In order for this to change, we would have to more than double output from mining just to meet industrial demand alone. Governments that used to hold silver reserves for the purpose of minting silver-based currencies no longer hold these reserves. (before the mid-60s, most U.S. coins were 90% silver, for example.)

The majority of silver is mined as an incidental result of mining other metals (copper, zinc, etc.) so silver would have to increase dramatically in price to warrant increasing the output of copper mines for this incidental side effect. Silver is currently being mined at a loss at current prices—it must cross at least $15/oz to be break even for most mining operations.

Bottom line, at the moment, silver is more rare than gold. There may be more reserves of silver in the ground than gold, but ramping up production of dedicated silver mines in a meaningful way would take half a decade or more– and that would just be enough to meet industrial demand alone.

I’m not saying gold isn’t valuable– indeed, I believe we’ve found a bottom for gold in the short to medium term of around 750. Gold continues to be the best physical store of large amounts of value. If I were making a bet over the next 50-100 years, I’d bet on gold before silver. Additionally, as a pure inflation hedge that is bought with the intent of never selling, gold is superior. I do hold gold for this reason– and I do not plan to sell it at less than around $1800/oz.

However, I believe silver, currently at historic lows relative to gold,** is poised for significantly greater gains in the next year or two** as the market realizes the information above. Gold will go up, but silver will, in my opinion, go up much faster. I think gold will go from it’s current price of under 800 to at least 1150 in the next 6-9 months… those are great gains… but in that same time I fully expect silver to go from it’s current price under 10 to the mid twenties or even low thirties.Silver to me is a speculative investment opportunity right now, not just a pure hedge.

The down side of silver vs. gold, of course, is volatility. It’s even more volatile than gold… (and that’s saying a lot!) However, I’m really young… I can handle some pretty big swings.

Note: Please readmy disclosure statement, and talk to a professional financial advisor before acting on any of the information presented here. Anyone making trades based on a blog post by ANYONE without doing their own research gets what they deserve.  :)   Photo Credit: DigitalCurrency