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How to make the biggest profits from gold and silver

Filed under: Gold & Silver — peterjcooper @ 11:00 am

Investors are being won over to the case for precious metals on a daily basis, and the case against this asset class is also weakening by the day. Time then to consider how to gear up to achieve maximum returns in this asset class, albeit with higher risk.

With the UK’s second largest bank, Royal Bank of Scotland predicting a stock market and credit crash within the next three months, it is hardly surprising that the bank’s latest fund for expatriates has a heavy weighting for gold. The ongoing geopolitical tensions between Israel and Iran are also reason enough for nervous investors to seek refuge in this traditional safe haven asset.

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Royal Bank of Scotland has given gold a 25 per cent weighting in its latest Autopilot capital guaranteed deposit account targeted at UAE expatriate customers. Performance is weighted equally across four sectors: emerging equities, developed equities, property and gold. The new fund will track performance of the four sectors when rising, and divert to cash when a falling trend is identified, so gold could be its sole investment class.

The role of gold in this new account is bound to raise eyebrows and comes as the bank is warning customers to expect turmoil in equity and credit markets over the next three months, an unusal statement for the second largest UK bank. Time indeed for UAE investors to consider a little diversification into precious metals.

This column has recently presented quite a detailed case for investment in gold and silver both on the grounds of the supply and demand imbalance in the market, and because speculative interest is likely to build in an increasingly inflationary global economic environment.

Buying bullion or coins and storing them is one approach. But what if investors want to gear up to achieve maximum leverage against the price movements that seem highly likely in gold and even more so in silver?

The most obvious vehicle is a futures contract. The Dubai Gold & Commodities Exchange has contracts available for gold and silver. They are intended primarily for jewelry manufacturers for hedging price movements but they are equally useful if you want to achieve a considerable level of exposure to precious metals without having to come up with more than a down payment.

The problem with options – when you are not using them to hedge against physical metal actually being delivered on a particular date – is that timing is crucial and very difficult. If you get the timing wrong by as much as a few hours an option can expire worthless, and you will lose the entire deposit.

This is why some professional investors in precious metals choose to avoid options altogether, and instead plump for buying the most risky class of shares in the sector: the junior exploration companies.

These companies are sometimes unjustly likened to dot-com stocks. It is true that the juniors raise and burn cash while they look for gold. But unlike the dot-coms they do actually own valuable assets in the form of exploration concessions. Such land claims will rise exponentially in value during a precioius metals boom, particularly if they are well located, for example near to existing operational mines.

The argument for buying juniors is the same as buying land during a property boom: the value of land claims will soar as a boom takes off. After 1978 in the last great gold boom junior exploration stocks jumped in value with 100 and 1,000 fold increases, and even the firms with the worst claims in poor locations did well.

Creating a portfolio of junior exploration stocks, with a basket of top stock picks, is a sensible approach rather than concentrating into one company. Then if a few turn out to be real duds then the performance of the rest should still deliver a handsome return. There are many specialist websites on the Internet offering good advice on junior exploration stocks, such as www.goldseek.com and www.golddrivers.com.

Another approach to leveraging precious metal prices is to gear up on what should be the outperformance of silver versus gold. So far in the 2000s silver has kept up its tradtional outperformance in a bull market, delivering twice the price appreciation of gold, albeit with greater volatility. This greater performance is a gift for the clever investor in precious metals.

Shares in pure-play silver companies should deliver an even higher performance than the metal itself. It is not hard to see why. Silver producers have relatively fixed production costs so if silver prices rocket then their profits will rise by an even higher percentage. Hence the share price is leveraged to the price of silver.

Again the smallest silver exploration companies may deliver the best absolute returns. But there are some very large pure-play silver companies like Hecla, Pan American Silver, Silver Corp and Silver Wheaton that offer strong leverage to the silver price without the additional risk of a smaller company. For more information there are specialists websites like www.silverseek.com and www.silver-investor.com which can offer more detailed advice on silver.

To conclude, UAE investors looking for an aggressive portfolio in precious metals with maximum leverage to price changes should be looking beyond bullion and coins, and towards investments in junior exploration companies and pure-play silver producers. In the final stages of this boom in gold and silver this is where the best returns will come just as in the late 1970s.

S&P reckons oil market not like the 70s but good for gold

Filed under: US stocks, gold — peterjcooper @ 3:59 pm

Today I caught up with Standard & Poor’s VP for commodities, Eric W, Kolts who was over from New York speaking at a conference in Dubai. He is resolutely bullish on oil prices, and rejected my comparison to the 70s.

‘I can remember what happened then personally and it was not the same. The 70s oil price spikes, and there were two big ones were caused by political interference in the marketplace, not the fundamentals of supply and demand.’

Mr. Kolts is of the opinion that the oil market has undergone a structural shift with demand way out of line with the capacity of existing installed infrastructure to deliver supply. This is very different from political interference –

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the Arab oil embargo of 1973 or the Iranian revolution in 1979 – and makes a correction in price far more difficult.

‘We have seen forward oil prices move up by an unprecedented $45 since the beginning of the year,’ he says. ‘Of course there is a speculative element but this is also the start of including the cost of new infrastructure in the oil price. It is a structural shift and if you are going to tap oil offshore in a place like Brazil this is necessary to pay the cost of extraction.’

On the demand side Mr. Kolts is convinced that the tripling of the GDP of China and India since the year 2000 has also produced a permanent increase in demand for oil as China’s one million new car owners a year are not about to go back to their bicycles. Yet the oil market is still puzzling.

‘We have seen the open position in WTI crude declining since July 2007 which implies short position covering and should be producing a decline in the price,’ he says. ‘But it looks as if over-the-counter trading is more than compensating with prices rising further out.

‘I think oil prices will prove far more resilient in this climate and that we are in a super bull market due to the long-term fundamentals of emerging markets which have now emerged.’

At the same time Mr. Kolts believes petrodollars will find their way into gold as a dollar hedge with silver ‘riding on the coat-tails’ of gold. ‘The Middle East and Russia were always the big buyers of precious metals when I was a trader in the 1980s and this is of course a hedge against inflation and a declining dollar.’

But clearly S&P’s top commodities analyst does not see the oil boom fading away anytime soon because of market fundamentals. ‘That would take a very deep and long US recession,’ he concludes. Interestingly Mr. Kolts is very bearish on the outlook for US equities.

Silver my top tip for 2008 as ABBA returns!

Posted on 25 May 2008 with no comments from readers

If you asked me today what would you do with a $10,000-$50,000 windfall, or $5-10 million for that matter, my answer would be simple: buy silver bullion. Silver is a leveraged play on the gold price and physically in very short supply. The same thing happened in the late 1970s when ABBA ruled the pop charts.

Silver is often over looked. Consider last week’s gain in the gold price which hit the headlines, up two per cent. Silver was up five per cent in the same week but you will not see that in a newspaper headline.

Maybe this is because silver is still regarded as a poor man’s gold. Silver sells for $18.10 per ounce compared with $925 for gold or cheaper by a factor of 52. But this factor is on a falling trend. It was 53 a week ago.

The long-run gold to silver ratio is 15. That means silver has to triple in price just to match its long-term average relationship to the gold price. It is absurdly cheap.

Just how cheap is silver? Consider the absolute price: $18.10 is still a substantial discount off the $50 all-time peak of 1980. Then I was an economics undergraduate at Oxford University and British Rail tea cost 19p a cup – today it costs more than five times that amount.

Indeed, I can not think of anything apart from silver that is cheaper in absolute price than in 1980. Even gold is up on the $850 spike of 1980.

The big difference between gold and silver is that silver is consumed by industrial processes while gold just accumulates. That is why there is only a tiny fraction of the amount of physical silver in existence compared with physical gold. If you are thinking about scarcity it is silver that should more highly priced than gold, not vice-versa.

Back in March this was only too evident. It was not the bullion dealers that ran out of gold in the price spike, it was silver coin shops that saw their stocks quickly exhausted. Even the Perth Mint is taking a few weeks to convert unallocated silver to allocated metal because the demand exceeds immediately available supply.

But the nice thing about silver is that it is affordable to the retail investor, at the moment. Gold coins are expensive, silver is not, if you can find them.

The demand for coins from retail investors is similar to what happened in the late 1970s. As a young student I found that pre-1947 UK coinage was valued above its face value for the silver content and fortunately my father had coin-operated launderettes as a business – so I used to sort the coins and make a profit selling the ones with a high silver content.

Later the silver price crashed and my little sideline was not worth the trouble. But looking back the sudden interest in silver coinage was an indicator of the boom, spike and crash that was to come in the silver price.

You can do your sums as to how high silver might spike this time. It is a narrow market open to retail investors – although buying by the ton is also possible. In the late 1970s the silver spike outshone the gold price spike but tracked the same chart for the same reasons as the tail-end of a money supply boom.

What we are seeing now is a repeat of the late 1970s with oil prices seemingly on an uncontrollable upswing and precious metals following upwards as a safe haven and hedge against inflation. And while it might be impossible to bring back the pop group ABBA from that decade, as they have all got older, price trends for gold and silver are a different matter altogether.

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