Saturday, May 14, 2011

Why Gold Will Outshine Silver

By DAVE KANSAS

Silver's halcyon days may be fading, but gold still looks like it has some spunk.

The basic arguments for investing in gold apply to silver as well. Precious metals act as a hedge against all manner of grim developments, including inflation (or deflation), currency frailty (chiefly the dollar), fiscal chaos (see Greece) and various geopolitical concerns, such as terrorism and civil unrest.

Fervent investors in precious metals tend to have a dark view of the world. Scratch a gold bug, and you might find a canned-goods enthusiast, or someone who thinks the world's currencies one day will collapse.

The gold-silver price ratio has gotten out of whack. During most of the past 10 years, the ratio hovered around 60, meaning gold was 60 times more expensive than silver. Silver's incredible surge over the past year has pushed the ratio down to 43, a level not seen since silver's last crazed phase in the early 1980s.



Sure, gold and silver have been great investments over the past couple of years. But silver seems to have taken on a more manic stripe, while gold has retained a degree of restraint. It is that divergence that argues for looking at these two metals differently.


Take the last two weeks. Silver is down nearly 30% this month in volatile trading. Such a move in the Dow Jones Industrial Average would equate to an eye-popping drop of more than 3,700 points. Tony Crescenzi of Pacific Investment Management Co. called silver's parabolic rise and subsequent skid a "tulip mania-style move."

Silver backers counter that even with its recent drop, the lesser precious metal has retained a nearly 80% gain over the past year. Of course, it was up nearly 150% two weeks ago. Over the past year, gold is up 23% and the Standard & Poor's 500-stock index is up 15%.

Even before last week's dive, things had gotten pretty crazy in the silver markets. On April 25, the iShares Silver Trust exchange-traded fund traded nearly as much dollar volume as the SPDR S&P 500 ETF. And CME Group, which oversees silver trading at its Nymex unit, tightened silver margin requirements four times in the last few weeks as the speculative fever got hotter.
[UPSIDE]

During silver's first week from Hades, which ended May 6, gold fell a more-modest 4.2%. Indeed, during the commodities rout last week, gold held up better than almost anything else, something overlooked by critics of precious metals who like to lump gold and silver together.

Clearly, gold and silver are trading in a different manner. Silver is more tulip, gold is more, well, gold. Silver's lower price has made it attractive to smaller investors who find gold a bit out of reach, helping to fuel the metal's manic trading. Silver is also a smaller market, about one-quarter the size of gold's, which adds to its volatile nature. And, not least, central banks prefer to hold gold rather than silver in their reserves, another reason why gold trades with more stability than silver.

Despite these market differences, silver backers are eager to keep the two metals tied closely together, hoping to bask in gold's aura.

"Silver will be a currency just like gold. It's logical to expect silver prices to go much higher," said Eric Sprott, chief executive officer of Sprott Asset Management, which oversees a $1 billion silver fund.

Along with the mania—silver bounced 5% on Monday, while gold has continued a more sober trading pattern—there are at least two other reasons to think silver and gold will have different futures. One is supply. While gold supply is well understood, silver bulls and bears argue about just how much silver is out there. Some analysts make the case that silver in batteries and photographic film is "recycled" back into the market, reducing scarcity. Silver bulls, of course, think that's a bunch of poppycock.

More important, the gold-silver price ratio has gotten out of whack. During most of the past 10 years, the ratio hovered around 60, meaning gold was 60 times more expensive than silver. Silver's incredible surge over the past year has pushed the ratio down to 43, a level not seen since silver's last crazed phase in the early 1980s. At its peak, back on April 29, the ratio narrowed to 31, a level not seen in three decades.

Silver bulls will argue that the gold-silver price ratio should reflect the 15.5 level authorized by France in 1803, or the 15 level outlined in the U.S. Coinage Act of 1792. It's more likely that the ratio will revert to modern-era norms rather than race back to the Napoleonic era. And that means that gold, more than silver, looks like the solid store of value today.

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