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Our best hedge investment idea currently is direct precious metals ownership, especially holding iShares Silver Trust (NYSEMKT: SLV) in brokerage accounts. With both investment and industrial demand pushing silver higher in coming years, this uniquely situated metal is in terrific position to benefit from the economic future we foresee. Silver retains the monetary hedge characteristics of gold, combined with the upside from industrial metals if emerging markets remain in strong economic growth trends. We believe this dual demand backdrop will provide excellent price support for silver in 2013, just like 2012.
For our money, the iShares Silver Trust is the smartest single precious metals investment, on a risk-adjusted basis. Here is a good link to a visual story on silver’s supply/demand, history, uses and production. In a nutshell, industrial uses for silver have absorbed most the annual mined supply for better than a decade. We like it mainly as a monetary hedge today against inflation and out-of-control money printing by western governments, as little above ground silver supply exists in a panic buying situation.
Gold has traded between 100 times and 15 times the prevailing price of silver the last hundred years. The Gold to Silver Ratio has averaged 55 since leaving a gold/silver standard for the U.S. Dollar during the 1960s and 1970s. Today’s ratio is about 52. It is estimated silver is 20x more abundant than gold in the ground, and historically in the U.S. monetary system for nearly 150 years of fixed gold/silver pricing and standards of exchange, silver coins were given a value about 1/20th that of gold.
While silver’s price shows greater volatility than gold, there may be substantially better upside in the latter part of this 12-year old commodities upswing for “poor man’s gold,” than gold itself. For example during the last half of the precious metals boom between 1975 and 1980, the gold to silver ratio fell from 45 to 15, with the silver price surging from US$4 a troy ounce to $45 over this span. All told, Quantemonics Investing is projecting DOUBLE the price performance for silver vs. the related gold price rise in 2013.
Based on trading in my accounts, gold and silver investments were one of my top investment ideas 12 years ago at the commodities bottom, but today represent more of a “hedge” position. When I quit the investment advisor/newsletter scene in the late 1990s, I recommended investors switch a large portion of their investment funds into gold and silver. At the end of the irrational technology boom in the stock market, hard assets like oil, grains and metals were at an extremely low long-term valuation vs. financial assets. Clearly ownership of such investments the last decade has turned out to be a bright idea. Today, commodities as a group are more fairly valued vs. other assets, with perhaps platinum and natural gas prices in the U.S. at the most “undervalued” relative setting.
We have Buy ratings on ETFS Physical Platinum Shares (NYSEMKT: PPLT) and ETFS Physical Palladium Shares (NYSEMKT: PALL). The platinum group metals may be the best “relative” buys of all the metals right now, from a long-term perspective. Supply/demand fundamentals are in an advantageous spot for bulls going into 2013. Mine supply is not projected to grow much, and demand could increase from rising emerging market economies and/or investor interest to hedge inflation generally. You actually “own” physical metals to back each product, an additional “risk” related benefit for PPLT and PALL investors. As opposed to the futures contract and swap ownership design by the majority of commodity ETFs, each unit represents actual ownership of platinum or palladium in a vault.
We currently have a Buy rating on SPDR Gold Trust (NYSEMKT: GLD) - the safest fiat money printing and inflation hedge, on a risk-adjusted basis. Some of the top finance brains on the planet have been rushing to gold the last several years, and remain quite bullish on this monetary hedge despite its meteoric rise from US$250 an ounce in 2001 (and $50 quote in 1972). Super-investors like George Soros and John Paulson have been stockpiling gold and this ETF specifically throughout the year. Gold remains low on the average investor’s list of buys today, while millions of Americans are actually selling gold at their local “We Buy Gold” store to pay bills or raise fiat money cash. This article has links to some of Eric Sprott’s arguments to own precious metals in 2012; Mr. Sprott is one of the more outspoken gold bulls of late.
Quantemonics Investing has a projected range for gold prices in 2013 of US$1500-$2500 an ounce, depending on a variety of economic variables. Without doubt, the aging demographic trend here at home, rising deficit and debt levels, and now promises of unlimited money printing by the U.S. Federal Reserve bank in the second half of 2012, all point to an acceleration of sovereign debt problems and monetary inflation in America for years to come. At some point in 2013 we may even see the U.S. lose its stellar, historically incomparable, sovereign debt credit rating built over hundreds of years of hard work, as Congress is diametrically opposed to dealing with our real world, deficit spending mess. A smaller, but honestly high, macroeconomic risk for America during 2013 is the Dollar is slowly losing its “reserve currency” status in global trade. At some point, with little or no warning, a major shift in investor sentiment regarding the Dollar’s real world "value" could shake the foundation of our economic system. If this event comes to pass, an excessive drop in stock and bond prices is all but guaranteed, while gold and silver go in the opposite, almost vertical direction.
Another hedge angle that seems appropriate today is ownership of Market Vectors Gold Miners ETF (NYSEMKT: GDX). The GDX creation owns a diverse list of the largest and most profitable precious metals miners on the planet. I personally have not been very high on gold and silver miners for several years, as they were “overvalued” based on sales and earnings, and oversubscribed by Wall Street thinking. However, this situation has changed markedly in 2012. In late 2012, the valuation multiples for gold/silver miners are quite low historically relative to the stock market generally and the overall interest rate picture in savings and bond alternatives.
A basic rule of thumb for the last century (holding a great track record) is to buy the miners when they are close to “market” normal valuations of current earnings and sales. Typically, gold/silver miners, with long lived assets, trade at 50%-100% premiums to the S&P 500 or Dow Industrial averages, when viewing simple valuation criteria. Right now the large miners are priced at 17x or lower trailing EPS, with the S&P 500 at 15. The steady rise in pricing for metals sold has combined with lackluster to down performance by stock quotes in the sector for several years, to translate into much better price to sales multiples than 18-24 months ago.
Using our long-term quant models and a stable metals pricing forecast for 2013 as a base, the Gold Miners ETF is about 20%-25% undervalued in December 2012. Given a rush of interest by investors into gold and silver from potential new wars or economic shocks next year, and a swing back to normal valuations historically, considerable upside exists in many gold/silver mining equities going forward. Overall, if you are bullish on the metals, the mining stocks are now a good hunting ground for leveraged upside.
In summary, iShares Silver Trust has been a core holding in our Covestor and personal trading accounts for several months. If you understand and can handle the potential downside in industrial metals (silver being one) from any downdraft in the global economy, the potential upside is for a double or triple in price in coming years. Using our US$2500 potential upside target for gold prices next year (a 50% rise if money printing gets out of control in America and Europe), we would project a similar but disproportionate rise in silver toward US$60-$80 an ounce, from $33 now. To be fair, silver has a projected range of $25 to $80 an ounce; depending on worst or best case economic scenarios in 2013. From our work, we are expecting the higher end of the range to be in play.
Chart courtesy of StockCharts.com
FULL DISCLOSURE: We hold iShares Silver Trust (SLV) and Market Vectors Gold Miners ETF (GDX) shares long in our mirror portfolios on Covestor http://covestor.com/quantemonics-investing and unrelated personal accounts. We do not currently hold positions in any other stock mentioned in this article. Quantemonics Investing, LLC is paid as a general publication information and data provider. All contents of the Quantemonics Investing service and blogs on the Motley Fool website are provided for information and education purposes only. You agree that the service is not to be interpreted as investment advice, as an endorsement of any security or investment, or as an offer or solicitation to buy or sell any security. Quantemonics, www.quantemonicsinvesting.com and the owners and officers of Quantemonics Investing, LLC do not provide specific and personalized investment advice, and are not registered as investment advisors or a broker/dealer. The trading of securities or investments may not be suitable for all users of the service. It should not be assumed that future results will be profitable or will equal past performance, and all readers should understand each security investment involves a degree of risk. Investors should not assume that profits or gains will be realized by any security or investment mentioned by the service or related blogs. Readers accept any and all potential liability, loss, expense and cost when making trades or investments in their own account. We recommend readers consult with a registered financial adviser before making any investment decision. Investors should not hold more than 5% of their portfolio capital in any single equity position, as a general rule of diversification. No compensation of any kind has been paid to Quantemonics Investing, LLC or related parties for company participation in our data service. The facts and information presented have been obtained from original or recognized statistical sources believed to be reliable, but their accuracy and completeness cannot be guaranteed. All opinions expressed on the service are subject to change without notice.