Optimist or Pessimist? Silver or Gold?

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Gold and silver are both lower as I write this, Thursday January 3, with the SPDR Gold Shares ETF (NYSEMKT: GLD) gold physical trust with a move down of $1.97 to $161.00 (-1.21%) and the iShares Silver Trust ETF (NYSEMKT: SLV) silver physical trust moving down $.74 to $28.95 (-2.48%.)  The catalyst for today's move was the release of the minutes from the mid-December meeting of the Federal Reserve Open Market Committee, in which some members sounded a cautionary note regarding the duration of the latest round of quantitative easing, with several in favor of ending the latest monetary stimulus by the end of 2013, sooner than expected.


Virtually every word coming out of the Fed has an immediate impact on gold and silver prices, so much that it is easy to lose sight of the fact that the Fed isn't trying to create market conditions but react to them.  For example, everyone knows that sustained monetary stimulus will eventually result in inflation -- the whole point of easing is to pump up the economy.   If the Fed is successful in pumping up the economy, they will ease up on the monetary stimulus, since they have set a 2.5% inflation rate as a point at which they will consider raising interest rates, and an expanding economy will increase inflationary pressures.  So policy success means ending the monetary stimulus early, and that would be bearish for gold (and silver,) hence today's drop.


But it is somewhat senseless for the market to be watching the Fed, since the Fed is watching the market.  Every swing of the pendulum brings a counter swing, and inflation-expecting bidders driving up gold can expect a reactive, inflation-dampening Fed.  Of course, inflation ultimately brings a deflationary response and vice versa, but that doesn't help people wishing to invest or trade today


One possible way out of the dead-end analysis of the swings of the pendulum is to consider the differences between gold and silver.  Other than use as jewelry, gold is almost entirely a monetary hedge, a store of value, an investment vehicle.  And even the gold that goes into jewelry can be thought of as an investment, in that you can take it out in the driveway and beat it with a hammer and it will still have its bullion scrap value.  Around the world, many people consider their gold jewelry to be precisely that -- a wearable store of value.

But is a store of value really an investment?  Investing legend Kyle Bass refers to gold as "a put on the stupidity of the political cycle."  And David Einhorn, another investing legend, notes that "gold doesn't even have a quarterly conference call."  Both of these statements can be boiled down to a simple but powerful truth:  politicians can do this that or the other to the economy, and this or that to the currency, but they can't print gold.  Ultimately, this view is completely defensive -- gold is insurance that can protect you from what politicians might do.  To be sure, insurance is a good idea, but it is not really an investment, is it?  My own view is that gold is not so much an investment to make money, as it is a place of safety to keep money  -- as the dollar erodes with inflation, gold stays constant.


But silver is different.  It is more of what we traditionally consider an investment -- that is, its demand goes up with an expanding economy, and so it is much more than an inflationary hedge.  In fact, silver is increasingly an industrial metal, like copper, or iron.  That is because as electronic devices have gotten smaller and smaller, and more necessary, silver has been used more and more in electronic components.  Silver is simply the best material to use in a variety of industrial applications.  In fact, over 70% of the silver that is mined in each year is used, and often used up, in manufacturing. To be sure, silver can be recovered and recycled, but it is often not economically feasible to do so.  For example, there may only be $.10 worth of silver in your cell phone or computer, making recovery unfeasible, economically.

The bottom line is that silver is a hybrid of sorts, both an industrial metal like copper as well as a precious metal like gold.  When we consider that dual status in the context of economic expansion/contraction and inflation/deflation, we can say that an expanding economy should ultimately be good for silver prices, as sales of consumer and industrial goods go up.  On the other hand, if there is depression and deflation, and resulting money printing to combat that deflation, then silver should follow gold -- down with all asset prices, and then back up as the Fed fights recession with more monetary liquidity.

So, for myself, I prefer silver to gold.  With silver, I think you have the same store of value hedge as you do with gold, for hard times, and the monetary reactions they bring.  But with silver I think you also have upside in good times of economic growth, because of its industrial uses.  I don't see the same argument for gold in that scenario.  Suppose the economy were exactly perfect -- high growth, low inflation.  If that were the case, why would anyone want to own gold?  So I guess the bottom line is, if you are a pessimist, buy gold.  But if you are an optimist or a pessimist, buy silver.


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