A case for gold and silver

SSL In The Money

with Justin Jones

Wednesday, February 08, 2012

With the current global economy in disarray, investors are wondering what they can invest in that will generate returns and protect their wealth. With countries such as Greece, Italy and Spain all facing debt problems, there is definitely a palpable sense of uncertainty hanging in the air. Whenever there is economic uncertainty, it is always best to hold cash and/or liquid assets. However, as currencies weaken physical assets such as gold and silver can provide a store of value as a way to protect our financial situation.

Let's take a closer look at the problems some countries are facing and their solutions. One method in which the US is trying to control its debt situation is via Quantitative Easing in which the Federal Reserve "prints money" -- creates money electronically -- and buys financial assets from banks. This creates excess reserves in the banks, giving them more money to lend at lower interest rates. However, this electronic money is not backed by any kind of asset or production. Money by itself does not appreciate but is simply a reflection of how we value production, services and assets.

It is the hope that lower interest rates would jump start the economy, but what good is having all of this excess money if there is no demand or inaccessibility due to factors such as a lack of income? To put this into perspective, in May 2007 the US unemployment rate stood at 4.4 per cent and by October 2009 it more than doubled to 10 per cent. Even though unemployment figures now stand at a three year low of 8.3 per cent, as Federal Reserve Chairman, Ben Bernanke said "the US labor market is a long way from normal". Psychologically, do you think that Americans will be looking to borrow money and to spend a lot? In turbulent times, people hunker down and as such spending slows, revenues drop and economic growth stagnates.

Similarly, many European countries are now facing debt problems and this is eroding investor confidence in the ability of these nations to service their obligations. As this happens, countries have to borrow money at higher rates to compensate for the additional risk and this only adds to the uncertainty. Investors therefore need to look at asset classes that can provide protection and returns at the same time. Precious metals provide a store of value to investors and gold in particular has been a safe haven for many.

Throughout our history, gold and also silver have been used as money or have been used to back currencies, for example, the US dollar used to be tied to the value of gold. Nowadays, a lot of the world's gold is hoarded and has been used as a hedge against inflation due to the fact that it just cannot be printed as more is needed. Gold has to be mined and processed. There is an inherent value in the production of gold that cannot be replicated using a paper currency. If we were to revert to a monetary system that was backed by an asset, we have already used gold as a standard and it's not unimaginable that it could be implemented again if need be.

Silver has similar attributes, however has a few more advantages to gold that are far more tangible. Though silver is more abundant than gold, it is used in far more applications in our modern world. Silver has the highest thermal conductivity as well as the highest electrical conductivity making it a prime metal for use in modern technology.

As the US Geological Survey highlighted in 2011, "The demand for silver in industrial applications continues to increase and includes use of silver in bandages for wound care, batteries, brazing and soldering, in catalytic converters in automobiles, in cell phone covers to reduce the spread of bacteria, in clothing to minimize odor, electronics and circuit boards, electroplating, hardening bearings, inks, mirrors, solar cells, water purification, and wood treatment to resist mold..."

Still, silver trades at values significantly lower than gold but has appreciated just as much over the past few years. According to the National Mining Association, the average price of gold was US$695.39 per ounce in 2007. Currently, gold is trading above US$1700 per ounce, an increase of over 147 per cent. At the same time, according to the Silver Institute, in 2007, the average price of silver was US $13.39 per ounce. Presently, silver prices are above US$33 representing an appreciation of over 146 per cent.

Exchange Traded Funds (ETFs), securities that track a commodity or index, provide a convenient way of doing this as they allow investors to own the precious metals without having to source and store the physical asset. There are a few funds that hold physical silver and gold and investors can buy shares in these funds. For example, Sprott Physical Gold Trust (up 8.33 per cent year-to-date to US$14.95) holds the majority of its assets in gold and Sprott Physical Silver Trust up 8.19 per cent year-to-date to US$14.53). Investors can also invest in both commodities at once through Central Fund of Canada Ltd, a fund that holds over 95 per cent of its assets in physical silver and gold and is currently trading at US$22.79 (a 16.28 per cent year-to-date gain).

Buying shares via an international exchange is one way of retaining liquidity as the investments can be sold in the event that cash is needed. However, it is important to note that while these funds have physical silver and gold, they do not mimic the actual prices of gold and silver perfectly and though this makes them less expensive than owning the physical asset and may mean less risk for investors it may also equate to fewer gains. Still these precious metals act as safe havens and allocating a small portion of your portfolio to gold and/or silver can provide a hedge against inflation and overall portfolio risk.

As the uncertainty in the global economy continues, precious metals are expected to do well. Since the start of 2012, gold has appreciated nearly 10 per cent and silver nearly 20 per cent. However, investing in these precious metals should not be done based on speculation but with a long term view due to the short term volatility in the markets.

Justin Jones is an Investment Analyst at Stocks & Securities Ltd. You may contact him at jjones@sslinvest.com

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A case for gold and silver