Silver has historically been regarded as a super-beta play on gold, in that it tends to rise higher than gold in rallies and fall further in downturns. But not this time, writes Moonraker's Jeremy Charlesworth
In a stark warning ahead of the emergency budget, David Cameron warned the UK needs to act quickly to stop the national debt doubling to £1.4trn in five years’ time. Meanwhile, Europe has decided the best way to tackle the debt strangling the euro project is to take on more debt, and the US has colossal debts of its own.
Given all this, it is not unfair to point out the Western world is drowning in debt. Thanks to extravagant public borrowing, several governments are seeing their finances approach breaking point. These debts are so high and climbing that it is also fair to ask whether they may ultimately become unserviceable.
The borrowing levels that we have seen over the last 20 years or so cannot continue to rise indefinitely at the same high rate. There are concerns that if another banking crisis hits then governments will have nothing left in reserve to bail out the financial system again.
As fears rise about such a scenario, serious questions are asked about the value of paper money that can be produced at the touch of a button, and quantitative easing serves to
undermine confidence in Western currencies. Investors are increasingly looking to those assets they see as holding real value such as property, certain equities and commodities, especially precious metals.
The turmoil seen in financial markets over the last few years has created a scenario that is highly positive for gold. It has returned 90% in the last three years (from $648.85 on 8/6/07 to $1237.15 on 8/6/10) and 29.9% over the last year to 8 June 2010 (from $951.82 on 8/6/10).
Given that gold is priced in dollars it is necessary to take into account currency movements to compare its performance to some more familiar investments such as the FTSE 100 and UK Government Bonds. This is shown in the table on the right.
The rise in gold has been so fast that some observers have started to fear that a bubble could be forming. But gold (and other precious metals) are far from that situation. This is because the deteriorating confidence in Western currencies is continuing, especially versus the currencies of non-indebted countries such as China and Brazil, and in my view, it will continue to do so unless there are unimaginable changes to the way Anglo Saxon Governments run their budgets.
But while gold has done very well and dominated the market’s focus on precious metals, it is interesting to note silver has not enjoyed the same rise in value. This is an anomaly in that silver has historically been regarded as a super-beta play on gold, in that it tends to rise higher than gold in rallies and fall further in downturns.
We have yet to see this happen so far in the current rally. Silver has been overlooked by investors in the rush for precious metals and the conditions are in place for a major price breakthrough in silver that could see it outperform gold.
Gold outperformed silver by 46% over the three years to May 31 2010 and silver, given the long-term correlation between the two metals, is due a catch-up, (although gold could also fall in price to restore the correlation). The charts currently suggest gold could easily trade down to $1185 and still maintain its uptrend. A break below this level for more than a day or two might signal the onset of a more lengthy consolidation period before the next price run.
It is likely that as gold becomes ever more expensive, investors will turn to silver as an alternative precious metal. Silver, which is currently trading around $18-$19 an ounce, also has an attribute over gold that strengthens its case for a rally: while both are coveted and preserved for their appearance, silver is continually consumed as well for industrial purposes. There is a very real and ongoing demand for silver because it has lots of practical applications and is widely used for example in plasma screens, mobile phones and coins.
My own feeling is that gold, now trading around $1,230 per ounce at the time of writing this article, could go much higher, quite possibly in excess of $5,000, although it is impossible to predict for certain, and if were to reach those levels there would be setbacks on the way. The gold market has been rallying strongly recently and is back to the high reached in mid May. At these levels, one can expect some ‘backing and filling’ or even a correction from a mildly over bought position.
A correction would create a buying opportunity for the longer term.
At present, we are not seeing the consecutive big rises that we would expect to see in the last days of a bubble. It will not be until gold is going up $150 a day that we would be there. It might be that gold only peaks above $5,000 or more for one day but at that point we would be seeing a real crisis of confidence in Western currencies that would most likely have been caused by colossal debt problems and governments would be forced to do whatever is necessary to resolve the problems.
In the meantime, investors would do well to look at how they can take advantage of the potential that lies in gold and silver, which are both driven by the same factors.
Investors might use ETFs, although these sometimes do not actually own the commodities investors might think they do. Some ETFs use futures, which can impact on tracking errors.
Another alternative is to use funds with managers who have the flexibility to take advantage of precious metals and other commodities in a variety of ways, such as holding them directly or investing in ETFs and the equities of companies involved in them, as well as shorting when necessary. Such a strategy is an ideal way to exploit one of the most exciting investment stories in the world today.
Jeremy Charlesworth is CIO of Moonraker Fund Management and manager of the Moonraker Commodities fund
