When I posted a few days ago that the prospects of gold stocks are tied to the direction of the stock market, few gold stock investors reacted positively to that idea, despite the fact that it was intended to benefit those who felt inclined to invest in precious metals. This post will further irritate those who, understanding the monetary pressure we're up against with huge government spending, refuse to heed the warning of long established facts.
When examining the investment thesis for precious metals, there are two distinct classes. The first is the gold camp while the second class is the silver camp. The gold group is the truly hardened investor with wealth, in dollars, to support an expensive habit. On the opposite side of the precious metal spectrum is silver. Silver is known as the "poor man's gold" and for good reason. Silver is what is purchased when the price of gold has run up so much that it is essentially out of reach of the johnny-come-lately "poor" precious metal investor.
For the purposes of investment analysis, silver has one advantage over gold and that is the fact that silver has been allowed to freely "float" in the open market. This is a major reason why it has been difficult to observe the relationship between gold and gold stocks from the period of May 1781 to August 1971. The last time gold didn't have some sort of government control in the U.S. was the period from December 1861 to January 1879. Silver tells us what many hope that gold could.
During the period from 1929 to 1932, the price of silver ranged from $1.29 down to the level of $0.24. This was a decline in the precious metal of 81.4% in a period of 3 years. Gold on the other hand was fixed at $20.67 as it had been, with a few exceptions, from the period of June 1834 to January 1934. It stands to reason then, that if your silver was falling during the declining years then gold, at a fixed price, would be in greater demand. However, silver was the true reflection of what the market attitude toward gold would have been had the price been allowed to float freely.
"The Dines Letter was openly baffled by the failure of the golds to rise during the 1966 bear market, and, again during the 1969 bear market."
- James Dines author of Technical Analysis. 1974.
Today, the price of silver is telling us something very important that should not be scoffed at or ignored. Because of the fact that silver is going up, on a percentage basis, more than gold, it is telling us that the speculators have taken over the market and are therefore buying at any price rather and at the best price.
On November 21, 2008, the London Fix for silver was $9.17. At the end of the day November 24th, silver closed at $10.04 a gain of 9.49%. Contrast the silver move with gold's 6.20% move and we've got a potential problem. After all, why would safe haven investors fore go the "ultimate" safe haven of gold for the unloved step-child silver?
This answer lies in the the fact that small investors and speculators are running amuck. Take a look at the stock of silver producers Coeur d'Alene (CDE) and Hecla Mining (HL) rising 72% and 78% respectively in the last two trading days.
Another quirk in the precious metals arena is the current rush to buy one ounce gold coins. The very fact that supply is limited has emboldened many precious metal fans to feel that the only direction for the price is up. From an investment standpoint this isn't the case. What is happening is that coin investments are being mistaken for having the same quality and impact as institutional or central bank bullion buyers. Unfortunately, the lack of coin availability allows the small investor to believe that there must be an economic reason for the high demand even though we are clearly experiencing worldwide deflation. Further proof of a speculative market is the wide bid and asking price of the coins. Dealers, knowing the market and the lack of liquidity, aren't willing to be in the position of being left holding the bag because of speculators.
Sadly, the small investor goes out and buys what they can afford without realizing the history of precious metal prices during the Great Depression which resulted in the destruction of all wealth. The current demand for gold coins and the rapid rise in silver above that of gold is similar to low-priced, low quality stocks going through the roof near the peak of a bull market or the real estate equivalent of Fresno, California properties appreciating 30% in a single year. The time for gold and silver will come when the markets have hit bottom. As demonstrated in the failed acquisition by BHP-Billliton (BHP) of Rio Tinto (RTP), now is not the time.
