Silver the New Gold?

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Silver was going parabolic from March till the end of April and the volatility was increasing significantly leading to amplified risk for market participants and market makers. This was merely a result of the nature of the futures which exist on silver and which require a fraction of the underlying nominal value of the contract as margin. Commodity futures often require only a 5-10% deposit compared to 50% for equities. The leverage in the commodities that have futures is significant and thus can give rise to large price movements. In the week that margin requirements were increased several times and subsequently led to an automatic sell off iron, a metal that doesn’t know futures, saw price increases of 7% illustrating the dynamics of futures associated to a metal.

Another factor that probably led to the decision to increase the margins was that silver was threatening to break the $50/oz level which could have propelled the price of silver much higher because there are no technical resistance levels above $50, the high achieved in 1980 following the attempt of the Hunts to corner the market. If one would inflation adjust the $50/oz high in 1980 one would currently get to about $140/oz a 270% increase from today’s $37.75 level (June 1, 2011). In case we would inflation correct the $800/oz peak for gold achieved in 1980 we would arrive at a gold price of around $2300-2400/oz an increase of “only” 53% from $1,535/oz.

Another reason that in our point of view has also propelled the silver price since May 2010 by 175% to its peak of almost $50/oz on April 25, 2011 was the accumulation by investors of physical silver. The market for silver is much less deep than the gold market and thus leads to much bigger price movements. The total mined gold in the world is estimated to be some 165,000 tons equal to a value of approximately $8trn at current prices of around $1,500/oz. According to some industry estimates there are in total some 25bn above ground silver ounces left. At $35/oz those ounces would represent a total value of $875bn one tenth of the value of gold. The big difference between gold and silver is that the latter is being consumed because in some of its industrial applications it acts as a reagent. Being an industrial metal silver also benefits from the “ongoing economic recovery”. Next to that the Central Banks don’t have any silver in their inventories anymore unlike gold. The billion of ounces that were still held in Government hands in the eighties were sold to supply the deficits between demand and mined production and scrap. Silver at $35/oz is also much more affordable than gold at $1,500 hence why it is called “poor man’s gold”. At present, June 1, 2011, the gold/silver ratio 40x in other words one would get 40 ounces of silver for every ounce of gold.

In the ongoing competitive currency devaluation that is taking place in favor of the ultimate currencies: gold and silver, silver performed much better in absolute terms but also measured in other currencies than the US dollar. It is our opinion that the currencies are ultimately the benchmark of people’s wealth!! Since May 2010 silver denominated in US dollars rose by 175% from $18/oz to almost $50/oz before the increase in margin requirements pushed the price down by 30% to $35/oz. Over the same period gold rose by “only” 31% from $1,200/oz to $1,575/oz. Though in Euros gold barely achieved the same peak level as reached in December 2010 of Euro 1,079/oz whilst silver measured in Euros exceeded its December high of Euro 23.1/oz by 47% reaching a high of Euro 34.1/oz on May 25, 2011. See the outperformance in silver!

(Click on images to enlarge)

We live in a more integrated world with more international trade and travel than ever before validating the importance of the relative strength and value of currencies. The purchasing power of a currency determines the amount of goods we can buy at home (determining import prices) and abroad (exchange rate). It is why we emphasize that the “currency with real/intrinsic value” investors buy to hedge themselves against competitive currency devaluations has to outperform in all currencies and not only in US dollars (all commodities are denominated in US dollars and therefore automatically have an inverse correlation with the US dollar). So the real benchmark for outperformance is not an absolute performance measured in US dollars but also the outperformance in other currencies. As illustrated above, the reason why we like (physical) silver, is because going forward in our point of view it will have the highest probability, better than gold, of outperformance in all currencies as for all the reasons mentioned in this article.

We believe that the devaluation of paper money can’t be stopped and is ongoing, we are at the end of a cycle. First of all the middle class, which act as an important buffer against boom/bust cycles in the economy, needs to be wiped out before the financial imbalances can sort their effect. The problems in Europe won’t be reversed, we have passed the tipping point, politicians and monetary authorities try to rescue the situation purely for their own benefit: re-election! Next to that they are not really addressing the structural problems that have brought us in the situation we are in. In fact what the politicians are doing is exhausting the system for the inevitable break down. The same is happening in the US where the housing market keeps on deteriorating, a development we predicted several years ago. Don’t be surprised if the housing market in the US will fall by another 50%. The reason is, that as previously stated, mortgage owners don’t have any real responsibility for their mortgages and can thus walk away whenever it suits them. And the more the market deteriorates the more homeowners will walk away. This puts incredible downward pressure on housing prices and the fall in house prices becomes a self- fulfilling prophecy. End May 2011 there were some 14.3m houses vacant in the US and it would take about 13 years to bring that number down to a more normalized level of 11.5m assuming April’s low annualized level of 551,000 new home construction. According to the Federal Housing Finance Agency home prices fell by 2.5% in the first quarter of 2011 or 9.6% at an annual rate, the fastest fall for any quarter since 2008. Anyway as a result of the ongoing weakness in the housing market we experience massive wealth destruction hence a destruction of the middle class which as mentioned before acts as a buffer in the economy. On top of that the banks still have enormous amounts of foreclosed houses on their books because they can easily finance it with almost 0% interest rates and because the banks anticipate that the market will recover as happened in previous cycles. Nonetheless what we are witnessing is the undermining of the financial system, paper money is thrown at the system whilst the structural problems are not really solved with an economy that is not showing any traction either despite the enormous stimulus. This is again clearly illustrated by the recent Institute for Supply Management (ISM) reported on June 1, 2011, that its purchasing managers’ index for the manufacturing sector plummeted to 53.5 in May from 60.4, the largest monthly drop in 27 years. The 50.3 figure is the lowest level since September 2009. All subindexes weakened in May. But the most important components, new orders and production, showed the largest declines, as they plunged by 10.7 points (new orders) and 9.8 points (production), respectively.

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