Inflation is all around us these days, whether buying food, petrol or searching for new accommodation. Interest rates are negative, and no government seems serious about putting rates up as the global economy slows. In this environment only one financial investment class is guaranteed to shine – precious metals.
Unless you seriously believe that the US dollar is about to stage a spontaneous recovery with Fed interest rates at two per cent, then stocking up on gold and silver this summer while prices remain low after the March hiatus, makes excellent sense.
Over the past week precious metals have taken a hit after remarks from Fed chairman Ben Bernanke that he is turning hawkish on inflation. But there is no action to back up this rhetoric in the markets. Do not hold your breath for a rate rise on August 4. It is not coming anytime soon. Lest we forget: US unemployment rose 0.5 per cent last month; US home sales and house prices are in free fall, and not expected to bottom for 18 months; high energy prices are dampening consumer spending and axing confidence levels.
If Bernanke raised interest rates in this environment Americans would send out a lynching party. More seriously any increase in interest rates would crash the bond and stock markets. Indeed, it is far more likely that the pressure will come in the other direction, either this autumn or early next year. Bond prices look expensive against surging inflation, while corporate profits are being squeezed by inflation threatening stock valuations. Both the stock and bond markets are set up for a crash, and that would mean lower interest rates.
Now if interest rates fall, say from the present two per cent to 'an emergency' one per cent, then the US dollar will take yet another tumble. Gold is inversely correlated to the greenback – so it will head in the opposite direction, and upwards in value. Silver is the precious sister of gold and will follow and perhaps out perform as it has historically.
There is a seasonal pattern to precious metal prices which has more to do with Indian festivals and their gold buying than the US dollar. That leaves prices weaker over the summer months with a tendency for a strong upward lift in September.
Last summer we saw gold prices trailing around the $650 an ounce mark, and then an autumn price surge from September that took prices to a peak of $1,030 by March. With prices hovering around $870 today that is still an advance of one third in price on a year ago. And with world inflation set on an upward march, and the US dollar poised for further weakness in the near future, the bull market for gold is far from finished. Oil is far above its previous inflation adjusted, all-time high of 1980 and more than three times its nominal price level in 1980. If gold prices are inflated by the same factor as oil since 1980 then the price of gold is $3,100 per ounce.
Now that is not to say that gold prices are about to surge to $3,100, although in an inflationary environment anything is possible. But this does make predictions of $1,200 this autumn and much higher next year looks very reasonable as investors become increasingly desperate to find a hedge against uncontrolled inflation.
There will also be more money pursuing fewer solid investment opportunities. The global central banks are effectively printing money with low interest rates to offset the deflationary impact of falling house and other asset prices.
This new money searches for a home, and is not necessarily attracted to assets whose valuations and price levels look uncertain. The money will go where it is most likely to earn a return, and precious metals with their comparatively fixed supply will rise in value as the supply of paper money grows, creating a virtuous investment cycle. But precious metals do not go up in a straight line. There is considerable volatility along the way. That is why buying cheaply during a temporary lull in metal prices is such a good idea. It worked last summer, why not this summer?
And do not get so mesmerized by gold that you forget about silver. In the late 1970s it was silver that delivered the biggest price rise of all when the Hunt brothers formed a pool with Middle Eastern partners to corner the market.
Only last week the Hunt family sold its privately owned Hunt Petroleum business for $4.2 billion (Dh15.4bn) leading to some speculation about how the family might decide to invest its new fortune. History does tend to repeat itself, and precisely the same arguments that first took the Hunts into the silver market at $3 an ounce in 1973 apply now. When their pool crashed in 1980 silver was $54 an ounce.
If silver is inflated by the same factor as oil since 1980 then the price is $194 per ounce, a considerable increase on under $17 today. And silver is the only commodity not to have passed its previous all-time high in the current commodities boom. Perhaps the Hunt family will prove once bitten and twice shy, but to invest in silver in present market conditions would appear shrewd.