Buying silver to hedge inflation and a bond crisis

Posted on 25 April 2010 with 2 comments from readers

Interest in buying silver as the precious metal best suited to hedging against inflationary government debt levels around the world, and a consequent imminent bond crisis, is growing among investors.

Articles on ArabianMoney.net about investment in gold and silver typically receive ten times more page views than items about investment in UAE stocks, for example. This does not necessarily mean that precious metals are actually the better investment but it does say a lot about investor sentiment and likely future momentum.

Silver bulls

Besides the bulls have a good case, and are still not leaning on an extreme position to justify buying precious metals. There is none of the top-of-the-market distortions of US economic data as seen in the stock market right now.

If you look rationally at 10 years of rising precious metal prices then the story to date has been one of slow but sure growth, leaving gold prices four times higher and the actually the best performing asset class of the past decade, apart from silver which is up six-fold, albeit with far greater volatility along the way.

There is no 80 per cent price spike in the past 13 months like US stocks. When markets spike it is almost always the time to get out. Gold and silver just are not there yet or even close to it. Indeed, the fundamental drivers of gold and especially silver prices are still in place.

Consider inflation, is it really under control? In the UK inflation is running at around 3.5 per cent against GDP growth of 0.4 per cent, so in real terms the economy is contracting by three per cent. Then again we hear reports of 20 per cent salary hikes in Chinese coastal cities and a bubble in Chinese house prices.

US stock market and silver

And surely the biggest forward predictor of inflation has to be the surging US stock market. Share prices are being pushed up by a monetary bubble with very little real evidence to support a strong economic recovery (see previous article). Once this bubble pops, up will go bond prices again, but for how long can that last?

Not for long surely if the laws of supply and demand mean anything. All over the world governments face mounting deficits due to their bailout packages and a shortfall in taxation from the worst recession since the Second World War. This means a gigantic government borrowing program is in progress.

We know this much for a fact and do not have to speculate. Now what normally comes with increased government borrowing? Higher inflation is the answer. This slowly, or not so slowly, devalues the debt burden of high bond issuance over time. The bond owners get a haircut to pay for government excesses.

Higher interest rates lower bond prices

Of course, what happens is that bond buyers wise up and demand higher and higher rates of interest to fund government debt. So you end up like in the late 1970s with high interest rates and high inflation. That also means lower bond prices as interest rates rise.

So you get a lot more buyers for gold and silver which are very tight markets on the supply side. In the late 1970s the gold price rose eight-fold from 1976-1980, and silver rose a staggering 25-fold. Silver is in shorter supply than gold, and so does better as prices take off.

ArabianMoney editor Peter Cooper’s latest book predicts $5,000 an ounce gold and is flying off the shelves at Amazon.com. You can order from the link on this website.