Fear drives up precious metal prices. Fear of war, defaults, inflation, civil unrest and anything that undermines trust in government. A week after the Lehman Brothers bankruptcy in 2008, gold and silver jumped by 15%. Three years later, during the height of the European government debt crisis, when the obligations of Italy, Ireland, and Greece resembled junk bonds, silver more than quadrupled in value, while gold increased 250%.
Today, fear of a financial collapse has receded, and so have the prices of both precious metals. Gold GCJ9, -0.16% sits at about $1,300 and silver SIK9, -0.25% languishes a little above $15. Is it time to buy at these bargain prices? The answer is yes, especially silver, but not for the reasons you think.
Few worry about inflation in today’s U.S. economy, but right after the Great Recession, when the Federal Reserve embarked on its program of quantitative easing to jump-start the economy, many were concerned that inflation would emerge. With unemployment reaching 10% in 2009, the Fed expanded money and credit, drove down short-term interest rates to zero, and bought longer-term government bonds and mortgages in unprecedented amounts. According to basic economic analysis, too much money chasing too few goods leads to inflation. But the last nine years have upended that conventional wisdom. Unemployment is now under 4% and inflation remains in check. Buying precious metals to protect against inflation today seems foolish.
But no one knows when the next monetary upheaval will hit. The trigger might be an unanticipated default by a big company that has taken on too much debt — and there are many of those owned by private-equity investors. Or inflation may spurt when we least expect it. Economists can forecast the next financial earthquake about as well as seismologists can predict a tsunami. They know it only after they see it, but then it’s too late to take cover.
Precious metals resemble insurance. We pay premiums before disaster strikes, hoping that we won’t need to make a claim. A small investment in silver and gold, less than 5% of a portfolio, serves the same purpose. We should buy insurance when the premiums are low and keep the coverage. Just let the protection sit there so you can sleep well at night.
The ageless storehouses of gold and silver work when nothing else does, like during the Great Recession. Both precious metals are excellent investments to hedge against unforeseen risks. Silver makes sense because it is cheaper, rises faster than gold when disaster strikes, and is easily divisible into small coins, just in case you need to buy a loaf of bread or an iPhone and paper currency doesn’t work. Gold also belongs in a portfolio, because a small amount goes a long way in settling obligations.
But right now silver is a much better bargain. It has declined by more than 65% from its 2011 peak while gold is off by about 30%. Portfolio insurance is cheap today. If you own silver, hold on. If not, buy it.
Keeping precious metals in the proper framework, a key but relatively small part of a portfolio, avoids the disaster of Nelson Bunker Hunt, the richest man in the world in the 1960s, who went bankrupt buying silver. Escalating inflation during the 1970s made everyone a buyer, but no one did it on a scale like the Texas oil tycoon. Hunt ultimately bought almost 200 million ounces, more than the combined annual output of the four largest-producing countries, and was accused of trying to corner the market. He denied the charge but wound up going bankrupt in the process of accumulating his horde.
How does the richest man in the world lose everything? Instead of treating silver as an investment, part of a portfolio along with other assets, he fell in love with the white metal to the point of obsession, buying more with borrowed money than even he could afford when prices declined.
The lesson: Buy silver now, but do not become obsessed.
Source : William L.Silber, Marketwatch