What are gold and silver saying about each other?

I like reading Howard Katz’s commentaries on 24hGold.com, because he is, as he describes himself, a one-handed economist.  Prudence, caution, and wisdom suggest that we should hedge our bets, diversify, keep our options open.  But, the real world demands action before we are ready and before we know what is happening.  The economist who on-the-one-hands and on-the-others leaves us ill-prepared for action.  At some point, you’ve got to make a call.  And, that’s what I like about Mr Katz.

In his most recent post, entitled “Silver”, the subject of which I will leave to the reader’s fertile imagination, he argues that “things are shaping up for a massive move in the entire precious metals group, and this move is entirely consistent with the fact that the Federal Reserve has more than doubled the U.S. money supply over the past 2 years.”  And he comes to this conclusion based on the movement of gold and silver markets, specifically the breakout of gold in Oct 2009 and the breakout of silver on Sept 3, 2010.

As far as the long-term is concerned, I could not agree more with Katz’s interpretation of where the markets are going.  Our political system has, for nearly a century now, been rooted in monetary and social expansion.  And, I am afraid I cannot think of a country or civilization that willfully reversed course once it entered that phase of its history.  And, that is because the forces of history, economics, society, of human nature itself compel us towards our destinies often despite ourselves.

But, leaving that kind of speculation aside for the moment and returning to the matter at hand, I would like to argue that Katz has misread his charts, or at least the relationship between the gold and silver charts.  These breakouts occurred nearly a year apart, and that is no mere accident.  The gold market over the course of the last year has been propelled by risk aversion.  Sovereign debt crises, especially in Europe, but also in Dubai; a slowing American economy and fears of deflation and double-dip.  And we can see this risk aversion in a number of assets, as we have discussed before:  the relative strength of the dollar, the yen, bonds, and gold.

The movement in gold this year differs from the trend of the previous decade insofar as it was debasement of the currency that was cheapening paper around the world and lifting gold and commodities.  Now, however, risk is coming back online.  And, as it does, gold is going to be relatively weak.  I believe that movements in recent weeks suggest that gold has topped out for the time being, although I would not rule out a last-ditch rally in coming weeks.

Silver, however, is a different bird.  It is primarily an industrial commodity now, and therefore the breakout that Katz has identified in that market suggests exactly the opposite of what he argues.  The markets have weathered the double-dip scare and are now ready to charge forward, but as the fear of risk dissipates, gold is going to be left in the lurch while stocks and commodities advance.  The profligacy of our federal institutions will for the, say, next six to twelve months manifest itself in these markets, not in metals as a whole.

When one considers the amount of high-octane money sitting in banks waiting for that spark of demand, the growth in those sectors may shock even the most bullish investors.  Now, once the stock, commodity, and even job markets catch fire and everybody starts talking about how everybody at the Fed is a genius, then you can start buying gold again.  Only then will inflation and an over-heating economy push gold to the levels that gold-bugs have been dreaming of.  But, the time is not ripe yet.

An AFP report in my local newspaper claimed that “Economists peddling dire warnings that the world’s number one economy is on the brink of collapse, amid high rates of unemployment and a spiraling public deficit, are flourishing here.”  If economists and the hoi polloi are that uniformly pessimistic, can there be any better bullish signal?

To summarize, the gold and silver markets are different animals.  In a period of high inflation, they can both be expected to outperform virtually every other asset, but in periods like 2010, where deflation and default have hung over the economy, gold can be expected to outperform silver substantially.  At this moment, however, the outbreak in the silver market is indicating a new phase wherein risk appetite will push commodities up and keep gold at bay.  In the long term, the resuscitation of risk will push gold back up powerfully, but just not yet.


1 comment so far

  1. […] Uncategorized | If I did not know better, I would think that the good Mr Katz was answering my response to his previous article on movements in the precious metals markets, particularly silver and […]

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