Why Silver is Better Than Paper
Have you ever seen anything like it?
Gold down – again… Silver down further – again… Aussie dollar down more – again!
Since topping out at USD$50 two weeks ago, the silver price has dropped 30%:
If that’s not a crash we don’t know what is.
The above chart is a weekly price chart so we’ve extended the price down to where it’s actually trading – around the USD$35 an ounce level.
What’s caused all this action? Well, I’ll touch on it again in Money Weekend tomorrow, but in a nutshell it comes down to this: over exuberance.
Now, that doesn’t mean to say silver won’t go back up again. But like any price action you’ll always find it overshoots to the upside and then overshoots to the downside.
The trouble is, it’s hard to tell at the time what’s a justified price movement, and what’s a bubble.
Recently several readers have asked what’s the difference between a bubble in house prices and a potential bubble in the stock market and precious metals.
In the case of the stock market, there’s not much difference. Apart from the fact that anyone who refuses to accept stock markets can fall in value needs their head seeing to. The last thirty years have seen more stock market crashes than… [Pause]
Actually, the last thirty years is pretty much reflective of how markets moved before the mental credit boom of the 1970s onwards.
If you look at this snapshot of the US market from 1928 until the mid-1970s you’ll see the Dow Jones Industrial Average gained about 123%… in nearly fifty years:
Now look at the returns from the mid-1970s to 2000:
It gained over 1,300% in less than thirty years!
It’s crashed and rallied a few times. But for the most part, passive investors are no better off today than they were ten years ago.
That’s because following the credit-fuelled boom of the 1970s through to the 2000s, the law of large numbers has played its part in restricting further growth.
Think again about the exponential function we wrote about in last week’s Money Weekend.
When you have so much money created over such a relatively short period, it takes an even greater inflow of money to first of all maintain the value of the market and then to push it higher.
The stock market has experienced that effect since 2000. The property market is going through the same effect now. And in its own way, silver has gone through it during the past six months.
Gold versus Housing – Part II
Last week we wrote this about the difference between the gold price and house prices:
“In other words, the easy credit created by banks directly pushed house prices higher. The money created by banks has been used to buy houses at ever increasing prices.
“In contrast, the price of gold has simply reflected the increased credit. Very little of the new money created has historically gone into buying gold.
“Or to put it another way, gold is like the thermometer you use to measure the effects of a credit-fuelled boom – but rising house prices are the actual fever… brought on by easy credit.”
Based on the stories coming out this week, it seems the silver price – but not the gold price – has been a victim of a similar speculative, credit-fuelled boom.
It explains why gold has pretty much held its ground, rising and falling no more or less than it has done for the past couple of years.
On the other hand silver went crazy.
And because a lot of the trading was done through leveraged futures contracts, when the market started to tip south it just snowballed.
The raising of margins by the Comex futures exchange, and news the world’s richest man – Carlos Slim – and hedge fund legend George Soros had hedged their long silver positions, sent the market plummeting.
So, what happens next?
As we see it, you’ll get a reversion to the mean for silver. After falling from USD$50 there’s nothing to say it couldn’t drop as low as USD$10 or USD$20.
But we doubt it.
Our bet is the current level is somewhere close to the low point.
If, as we suggest, you look to buy into precious metals in increments – much as you might stick a few hundred dollars a month into a savings account – it’s hard to see how you can go wrong buying in around today’s price.
Of course, those could be famous last words!
But that’s the thing when leverage takes a hold in any market. It distorts it.
It distorted the stock market. It has distorted the housing market. And this week you’ve seen in quick time how it distorted the silver market.
But silver wasn’t the only commodity to take a hammering. West Texas Intermediate Crude Oil took an 8% pounding overnight, dropping below USD$100 a barrel.
And Brent Crude fell similarly, trading as low as USD$110 a barrel.
Pretty much across the board, commodities were down.
So, what does this all mean to you? What should you do with the gold and silver we’ve suggested you buy over the past three years since we started out as editor of Money Morning back in 2008?
Well, our advice is the same as the advice we give to unleveraged property owners – don’t sell.
If you’re not leveraged, then the cost of carry for precious metals is low. Of course, the cost of carry for property is much higher, but even so, if you’re unleveraged – or low leveraged – then it should pay its way.
It either provides you with shelter, or if you’ve got an unleveraged investment property, it should provide you with positive cashflow.
Problems only arise when you’re over-leveraged… especially when you’re using leverage to buy at the top of the market – that’s the same for silver or property.
But if you’re using cash to buy silver, we wouldn’t worry – your editor isn’t – even following a 30% drop. The way we see it is that central banks are in no hurry to stop printing money.
Buy more while the bankers keep printing
And neither can they stop printing money. A Ponzi fiat currency needs monetary inflation in order to survive.
And so, as long as the central banks keep printing and as long as fiat paper money clings on for dear life, precious metals prices will continue to maintain their value over the medium to long term.
But look, as always, you need to make up your own mind on this stuff. The way we see it, it’s not an emotional decision to buy precious metals, it’s simply a financial one.
History shows that precious metals rise over time as governments and central banks devalue paper money.
Remember, for the past few thousand years, paper money has been the exception. For the most part economies have backed their money with gold.
But whenever the backing has ended it has always resulted in inflation. And you don’t need to look back to the Romans or Weimar Germany for evidence. All you need to do is look at the recent experience from the 1970s through to today.
So, right now as we see it, there’s no reason to think it’ll be any different this time. Because, very rarely are things in the financial world different to the past.
Money Morning Australia