Has Silver Stalled?
Douglas is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Over the past weeks, a number of key economic indicators and measurements have led some to question whether those factors believed to be driving precious metal prices are legitimate catalysts. This inquiry covers both figures – including the unemployment rate and the core PPI – that come out of the Bureau of Labor Statistics (BLS), and the very nature of the latest round of quantitative easing. While this investigation raises important questions about the future of silver and gold prices, ultimately I believe they reach incorrect conclusions and exclude critical factors. Silver has plenty of upside over the medium and longer terms, and Silver Wheaton ) remains the best way to gain exposure.
While it is hard to argue with a nuclear physicist – I am honestly not exaggerating – the indicators available in the market support the conclusion that the economy is on the cusp of a highly inflationary period that will favor exposure to silver. The critics to a continued uptrend in silver point to an unemployment rate that has fallen to 7.8% for a single measurement, an increase in the core PPI of only 0.1% and the fact that the Federal Reserve’s latest round of quantitative easing targets mortgage-backed securities (MBS) rather than treasuries. The most orderly way to proceed will be take these critics in order:
Unemployment – While the “effective” rate of unemployment fell to 7.8%, the first time that figure has been below 8% in 44 months, the U-6 rate remains unchanged at 14.6%; this figure includes underemployed workers and those who have “stopped looking.” This last term includes those who are still looking but have exhausted their unemployment benefits. The unemployment rate is important in this context for two reasons: First, if the employment picture is improving, it opens up the possibility that QE3 will be brief; and, second, it suggests that the economy might be improving and that investors who have fled to the safety of precious metals may be able to return to other assets. Given the less than accurate precision of the statistic and the reality that one decent report proves very little, unemployment is, at best, inconclusive. The U-6 rates suggest the economy is still struggling.
The Core PPI – Both the core PPI and CPI purport to be measurements of inflation, excluding the impact of food and energy, which are considered too volatile. While there is some research that supports the contention that core PPI is the best leading indicator of future inflation, particularly in an investment context, the problem is that, as with any single statistic, the core PPI misses paradigm shifts. Given the exploding deficit over the last four years and the general weakness in the economy, the Fed has abandoned its dual role of maintaining employment and keeping inflation in check. We know this because it said so when QE3 was announced. Unlike any time in recent history, the Fed needs inflation to allow us to repay debts with much cheaper dollars. If you have never heard the expression “You can’t fight the Fed,” I’d suggest learning it.
The Nature of QE3 – The argument that buying MBS instead of treasuries demonstrates that inflation concerns are overblown also fails. It is premised on the idea that QE3 represents “purchases of value.” Beyond simply pointing out that if MBS were so valuable, the banks that own them would not be selling (I’ll avoid a discussion of QE3 as another wealth transfer to the banks because that is an enormous topic in its own right), we can take the discussion a bit further. Quantitative easing means adding dollars to the money supply – this drives inflation. End of story.
Why the Lag?
As we draw ever closer to Election Day, investors should not be surprised to see various markets take a breather. Particularly with the economy being such a central factor, it is not surprising that disaster insurance assets like silver have lulled. Using the iShares Silver Trust : SLV) as a proxy, you can see that silver prices have been fairly stagnant over the last several weeks. This may continue through the election, but using pullbacks as an opportunity to establish a position is prudent.
How to Benefit
Given that the current course of monetary policy in the U.S. is targeted at creating inflation, the uptrend in silver should remain well intact. Silver Wheaton remains the best investment in silver based on its business model, growth prospects and market position. As a streaming company that buys mine production at a predetermined price, the company is not exposed to ballooning mining costs. More typical miners, like Pan American Silver ) have faced rapidly rising costs that have cut into both their operating margins and their bottom lines. This is one of the many factors that are responsible for Silver Wheaton having a projected annual growth rate for the next five year of over 35%. The company is well run and promises to deliver great long-term returns. It is a buy at current levels.
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