Soft gold prices without hard-money rates? Not for long, says the world’s 40-year unbacked money so far…

JUST HOW MUCH ABUSE can soft money take? Two-thousand-and-eleven sees a big, but so far little-noted ruby anniversary. Expect to hear lots more about it as August 15th draws near.

Because that day will mark 40 years since the United States’ government finally stopped redeeming its dollars for gold. That ended over 250 years of formal “gold backing” for the West’s dominant currencies. It also took the entire world off precious-metal money for the first time in 5,000 years of civilization.

Gold wasn’t being used as money in Aug. ’71, of course. Long banished to central-bank vaults, the ageless metal was represented instead by paper notes – the medium of exchange – in purses, wallets and tills. Nor did gold bullion bars back more than $1 in every four in circulation, gradually slipping from the 40% cover-ratio set during the Great Depression. And unbacked money had also been tried many times in the past as well. Persian kings, Mongol emperors, Scottish chancers in the French court, desperate men at the Reichstag…they all thought they’d found “the secret of the alchemists”, as Marco Polo called China’s paper-note chao in his Travels of the late 13th century – and they all found it disastrous.

But irredeemable money had never been applied worldwide before, and never without some element of “hard money” (meaning gold or silver-backed notes) running alongside. Since US citizens were pretty much barred from owning physical gold, however, removing the metal from inter-government settlement looked a small, inconsequential step to most, especially next to the wage and price controls Richard Nixon also announced in his “Sunday special”. (Tricky was apparently worried about upsetting voters by delaying the latest episode of Bonanza on TV, but he was more anxious still to break the news before markets opened on Monday 16th August.)

Indeed, refusing to redeem foreign governments’ Dollars for US gold bars should have played well to the crowd. Because Nixon was defending the States’ ultimate hoard against those overseas partners who dared to doubt Uncle Sam’s promise to…ummm…redeem his paper dollars for gold. France alone had swapped $250 million for gold in “recent months”, the Financial Times reported on 5th August, helping draw the US gold reserve down to “just over $10,000m, the lowest point since the early 1930s,” as the paper said four days later.

“There has naturually been a revival of the traditional theory that when the gold stock hit $10,000m, the US would simply close the gold window,” the FT explained on 9th August, adding that “There is no evidence that the Nixon Administration plans such action,” even as the Dollar crisis continued to make its front page each day.

Slamming the window shut, just as the “theory” suggested, “We must protect the position of the US Dollar as a pillar of monetary stability around the world,” Nixon told the nation (and the world) on 15 August, 1971. But as his central-bank chairman, Arthur Burns of the Federal Reserve, had feared (“What a tragedy for mankind!” wrote Burns in his diary) the early results soon proved as awful as they were entirely predictable.

Freed from gold’s seemingly arbitrary limits, money bred so fast – everywhere – that wholesale and consumer-price inflation reached untold peace-time levels, crushing savers in both the equity and bond markets pretty much worldwide. Freed from its official peg, in contrast, gold prices rose 20-fold. The public grew so discouraged that, within a decade of Nixon’s decision, his Republican successor, Ronald Reagan, ordered a commission to consider reversing it.

But thanks to those falling bond prices, however – which came thanks to bond buyers everywhere demanding ever-higher interest rates if they were lend money for any period of time to government – Washington got to ignore the Gold Commission’s minority report, and extend the world’s experiment with unbacked money for another 31 years (and counting…).

Because by 1980, and thanks to those soaring bond yields, central bankers had already stumbled upon the solution to unbacked money’s first global crisis…

Hike interest rates so high that cash-on-deposit actually starts paying a positive real return, post-inflation. The effect on gold – and so on any thought of returning to gold-backed money – was signal, as you can see.

Over the first-half of the 1980s, real interest rates – paid over and above inflation – averaged nearly 5% per year. Major-currency savers hadn’t seen anything like it since Great Britain fought to defend (and lost) its own Sterling Gold Standard half-a-century before. And together with those desperate Gold Standard-style interest rates, the Dollar recovered something like a Gold Standard poise.

Peaking at almost 15% in 1980, the pace of US inflation then fell by more than two-thirds in the following half-decade. The Dollar gold price did the same, sliding from its (then) record peak of $850 per ounce to less than $285 five years later.

Why? Mining supplies rose, and the peak prices of 1979 and 1980 unleashed a torrent of scrap-metal supply back to market, too. But negative real rates had forced a growing number of otherwise cautious savers to abandon money for gold throughout the 1970s, just as they have again since 2001. Whereas strongly positive rates, in contrast – and positive like nothing since the scramble for gold of five decades earlier…when global bullion flows determined (and were thus targeted to maintain) international currency values – worked the opposite way. Because no one needs an inflation hedge, a defense against devaluation, when cash-in-the-bank pays 5% more. And that victory was so hard-won, the stability it brought to unbacked money continued even as real rates eased back…pretty much until they neared zero a decade ago.

Here in early 2011, cash savers and central bankers alike stand so far removed from gold-backed currency, let alone from gold-as-money itself, the idea of returning to redeemable notes seems ridiculous. But those killer rates of 1980-85 remain the only sure lesson of how confidence in unbacked money can be won back once it’s begun to dissolve. This month’s gold-price jitters, therefore, are both understandable and absurd. Most sensitive of all assets to a switch in interest-rate sentiment –and so clearly buoyed by the Fed’s repeated promise of “exceptionally low levels…for an extended period” – gold has turned 6% lower on inflation data that points higher, even as Western central banks make plain they’ve no plan of responding, and China holds its real rates some 1.5% below zero for cash savers.

Soft gold prices without hard-money rates? Not for long, we’d guess…not after faith in unbacked money has begun to dissolve. But the feint of 1975-76, however, might say otherwise.

Check the chart above. Gold prices halved even as real US rates stayed sub-zero but pushed upwards. Gold then rose 8-fold as rates fell again, finally forcing those very same hard-money rates which confidence in unbacked money demanded.

Adrian Ash

For Money Morning Australia
Adrian Ash is head of research at www.BullionVault.com

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I’ve always had a soft spot for silver.

It’s the people’s precious metal.

It’s gold’s cheeky cousin.

If gold’s fine dining, then silver is a lazy Sunday roast with your family.

And something amazing has started in the silver market.

The silver price took nine long months to crawl from $18 to $20.

It then jumped by 50% to hit $30 in just three months.

Silver off like a fire-cracker

Source: goldprice.org

It now looks like it will finish up by about 70% for the year, leaving other commodities for dead.

This is not normal! What IS going on?

Our first silver tip at Diggers & Drillers is now sitting on a gain of 87.5%. To build on this, I’ve just recommended another silver tip to cash in on silver’s new bull market.

If you haven’t been keeping up with silver lately, a lot has happened. There is a huge move in silver which could continue into 2011. So, what’s behind it?

Compared to gold, the silver price had been pretty flat for a year. Then a good old-fashioned scandal got things moving.

A few months ago, Bart Chilton of the Commodity Futures and Trading Commission (CFTC) said he “believes that there have been repeated attempts to influence prices in the silver markets”.

Global banking firms JP Morgan and HSBC now potentially face class action lawsuits alleging they had forced silver prices down for their own benefit.

Once Chilton blew the whistle, it was game-on. The silver price started playing catch-up without fear of getting crushed by the big players. The price may be jumping like a kid on red cordial, but I reckon it still has a long way to go yet.

But how much further can silver go?

Well, for the last few thousand years the gold price has been fifteen times more than the silver price on average. This wasn’t by design, and was probably just because gold is fifteen times rarer than silver in the earth’s crust.

This fifteen-to-one ‘gold-to-silver price ratio’ stayed true through history right up to start of the twentieth century.

Then as Central Banks grew in power, silver was kicked off the podium and lost its importance. It soon became a shiny financial relic from a ‘less educated’ time.

So the relationship between the gold and silver price changed completely. So much so, that silver has been around seventy times less valuable than gold for the last few decades.

This belittles silver. It’s like seeing an old mate queuing up at the soup kitchen.

But all this is changing. Paper money’s value was based purely on the bond of trust we have in Central Bankers. But this bond has been broken.

I believe the market is now witnessing a once-in-an-investment-lifetime event.

A whole asset class is suddenly re-valued on a different basis. Precious metals functioned as money for thousands of years, and after forty years off-duty are returning to this role. They are ‘remonetising’.

Silver is coming out of hibernation, and is now back on its feet and fighting. Money is pouring into the silver market, as investors rush to allocate funds into what little silver is still available.

So as the silver price races to catch up with gold, the gold-to-silver ratio is falling like a stone. Silver’s price jump means it is now just fifty times less valuable than gold.

Gold to silver ratio returning to former glory?

Source: Goldprice.org

But the silver price would still have to triple to more than $90/ounce to get this ratio back to its historical average of fifteen to one.

Is this really possible?

Because, as you should know from any financial advice disclaimer, ‘previous performance does not guarantee future returns’. Mullets were cool once upon a time. Just because something happened in the past, it doesn’t mean it will come to pass again.

Although, looking out the window onto Fitzroy Street, St Kilda, maybe…

Anyway, if you take a quick look at the silver market today, it’s coiled like a spring waiting to pop.

There are only 1.2 billion ounces of silver bullion in the global ‘stockpile’. At $30 an ounce, there are only $33 billion worth of silver available. I’ll put that in context.

The value of the entire global silver stockpile is less than Woodside Petroleum’s market capitalisation.

Considering how many buyers there are worldwide, this market is tiny!

Silver is being bought by the ute-load. Coin sales have gone through the roof. The US Mint, Canadian Mint and Perth Mint are all setting new record silver sales each month. The urgency of the demand means that a one kilo silver bar is now going for a 10.6% premium to the spot-price of $945.

But the real game-changer is the money going into Exchange Traded Funds (ETFs). Incredibly these hold about 60% of the world’s silver stockpile already.

There’s really not much silver out there left to buy, and the ETFs are quickly buying what’s left. They snapped up another 1.5% of the global stockpile in November alone.

It would take less than two years to mop up the rest at that rate.

Silver also has an unusual supply problem, which keeps things tight. Eighty per cent of silver supply comes as a by-product from mining companies producing other metals. Silver is not their main concern, or source of revenue. When demand increases, these producers don’t give a monkey’s.

It won’t increase the silver supply:

• Huge investment demand pouring into a tiny market?

• Only two years left of spare silver?

• Mine supply that doesn’t give a rat’s?

These fundamentals will only push the price one way in the long term! Up.

But more than any of this, what is driving the price up is that it silver has just had the brakes taken off, and it can now get back to turning into money.

It’s getting back onto its podium and is ‘remonetising’ once again.

The silver price may yet pull back briefly after such a big run, but even after a 68% rise, it still looks cheap!

It may have had a big 2010, but my money’s on this continuing throughout next year.

Regards,

Dr.Alex Cowie
Editor, Diggers & Drillers

Poor National Australia Bank [ASX: NAB]. Or I should say poor customers of National Australia Bank.

Another so-called “glitch” struck it again yesterday afternoon. Twice in the space of a couple of weeks. Dear oh dear.

If you’re an NAB customer I’d suggest twice is enough. It’s time to shift your savings account somewhere else.

But we’re not going to write about Australia’s insolvent banks today. We’ll leave that for tomorrow. It should be a corker so make sure you tune in…

Your editor nearly fell off the couch while watching CNBC this morning.

There isn’t much on that channel worth watching, but we watch it anyway. Usually while tucking into our three Weetbix®. We try to ignore the blathering hosts and their drone-ish guests by turning the sound down.

Instead we just follow the ticker at the top of the screen… Dow Jones… S&P500… AUDUSD… USDJPY… Gold… Silver… UST10YR… zoiks…

With all our focus on the Aussie banking system over the last couple of days, we’d taken our eyes off the yield on the 10-year US Treasury. What we saw nearly caused the couch-falling incident.

And we could see why Money Morning reader Jack had sent through this email yesterday afternoon:

“In your discussion toward the end of today’s MM, I’m surprised you did not pick up on the 10year & 30year USGovt bond prices falling (thus yields rising) during the time since they announced & implemented QE2.”

We had noticed the rising of the bond yield since early November. It was something that flew in the face of the supposed reason for the money printing – to keep interest rates low.

But what we hadn’t noticed was the price and yield action over the past few days. The chart below explains it all:

Source: Yahoo! Finance

It’s important to know that price action in any financial market is based just as much on what investors think will happen as on what has happened.

So you can argue that leading up to early November when the US Fed announced its money-printing programme, investors were positioning themselves for what they thought the Fed would do.

They thought the Fed would print a certain amount of new money (not actually printing it, but creating it electronically) and therefore bought or sold US Treasuries on that assumption.

When the Fed made its announcement some punters saw this as the time to get out. The price had risen (yield fallen) as far as they thought it could go. What were they to do next? Hold on to an investment yielding less than 3% for the next ten years? Or sell it and lock in the capital gain.

The latter obviously.

Especially if they were in leveraged positions… which they would be. Remember, even retail investors in the US can get 10:1 leverage on government bond. So goodness knows what leverage the institutions can get. That’s because they’re seen as safe investments.

In contrast, in the US, a retail investor can only get 1:1 leverage on stocks. If you know the Fed is going to print a whole bunch of fresh cash to buy up these bonds, why wouldn’t you front-run the Fed and look to profit.

Well, that’s exactly what they did. And now they’re getting out.

Even the prospect of further money-printing may not be enough to draw buyers back. And if it does there would still be a big bunch of sellers trying to cut their losses and get out.

It’s a problem the Fed has created for itself. If you think about it logically it makes sense. Unfortunately, logic is one of the things in short supply at any central bank.

The fact is, the more new money the Fed creates to push down bond yields, the more new money it will need to create in order to push them down the next time. The Fed is creating 600 billion new dollars to lower interest rates.

So far it has only spent about one-sixth the amount – this morning it bought another USD$1.63 billion of US Treasuries. The bond market is becoming desensitised to the Fed’s bond buying programme.

Bond yields will undoubtedly fluctuate, but will it push rates back down to the level the Fed wants? We doubt it.

So what next? That’s where QE3 and QE4 come into play. But the Fed can’t announce it’s going to just buy another $50 billion or $100 billion… that won’t cut it. The market won’t care. It won’t have enough of an impact on the market to attract bond buyers.

If the Fed really believes printing money is the solution to helping the US economy. And if it believes this involves keeping interest rates low the only action it can take is to really ramp things up… one trillion dollars, two trillion dollars… or more likely, just an open-ended buying spree.

But just as bond buyers have become unimpressed with the Fed’s bond buying so soon, can they be relied upon to maintain enthusiasm for an open-ended bond buying programme?

We doubt it. And that’s when it’ll get super exciting. Not only will the Fed become the main buyer for existing debt, but it will become the main buyer for new debt – bidding for bonds direct from the US Treasury.

In other words, skipping the middleman.

The way we see it is that all the elements for an inflationary super-spike are being created right now. The rotation of new money from the Fed to the market to the government is speeding up… then it’ll reach terminal velocity, and the economic ship won’t be able to take it anymore.

There will be so much worthless paper and electronic money flying around the US and global economies that consumer prices will soar and the economy will collapse. What will that mean for commodity prices?

Well, if you want an example of what to expect, look at the price action for bonds. What has happened with the 10-year US Treasury is a perfect example of how inflation doesn’t necessarily increase asset prices… or I should say it doesn’t necessarily keep asset prices high.

It’s all about expectation and anticipation. Bond buyers expected new money to be printed (inflation), so they bought an asset in advance. Now some of the new money has been created the bond buyers have lost interest. They’ve already priced it in.

And bond prices are falling. Yet there’s still more than USD$500 billion of new money waiting to be created at the tap of a button.

Why shouldn’t that happen for other asset prices?

There’s no reason it shouldn’t.

Commodity prices have already taken off. You can see that on the RBA Index of Commodity Prices:

And it’s a pretty good bet prices could go higher.

But when it comes down to it, a commodity bubble is like any other bubble. Investors and speculators bought US Treasuries because they are supposed to be safe, and also to front-run the Fed’s buying.

As for commodities, investors and speculators are buying commodities because they are seen as a hedge against inflation and because of the growth of emerging markets.

But when it comes down to it, commodities are produced to be used. Businesses buy copper, corn and sugar because they need to use it to produce goods. But in addition to that, there are investors and speculators buying and selling these commodities in order to make money.

But ultimately, the price investors and speculators will pay depends on what they believe the underlying supply and demand is for the commodity.

And also don’t forget that buying by end users, investors and speculators is done using leverage. When the credit taps dry up – as we saw in 2008 and 2009 – the ability for end users, investors and speculators to keep buying becomes much more limited.

So if the buying dries up, that’s right, it becomes a buyers’ market. Sellers jump over each other looking to be the first to the exit.

In other words users, investors and speculators are buying commodities based on certain expectations. A variety of expectations. Once those expectations change, the price correction can be savage.

And as you know, very rarely – if ever – is everyone right about the ultimate price of an asset.

The commodity bubble has already burst once. The chart above shows you that. There’s nothing to say it can’t burst again.

Just as front-runners helped push bond prices to an unreasonably high level based on certain expectations, the same is happening right now in commodity markets.

Staying on board to profit from this surge makes a lot of sense – as Dr. Alex Cowie has done in Diggers & Drillers. But assuming it will last forever and that inflation, China and India will provide a backstop to commodity prices is a risky game if you don’t know what you’re doing.

Cheers.

Kris Sayce
For Money Morning Australia

Today, we’ll show you why silver could potentially be one of the cheapest assets in the world right now. The silver market is not at all analysed by mainstream investors and for this reason remains very much overlooked as an investment opportunity.

As proponents of sound money, we believe precious metals, most notably gold, will have an increasing role to play as the current unsustainable system evolves to a more stable footing.

If gold’s role as money becomes increasingly recognised then silver will also come into the picture as a monetary metal. In the previous article quoted Milton Friedman as saying ‘the major monetary metal in history is silver, not gold.‘ This fact hasn’t been forgotten.

As you will see, investment demand for silver is beginning to grow very strongly and conditions are primed for this growth to continue. If this occurs, silver will effectively be ‘re-monetised’. As such we expect to see the gold/silver ratio to move heavily back in silver’s favour in the years ahead.

Silver Supply and Demand

To understand why this may be the case you first need to consider the fundamentals of the silver market. That is, the supply and demand factors.

Let’s look at supply first. In 2009, 80%, of the world’s supply of silver, or 709.6 million ounces, came from mine production. Peru was the largest producer of silver with 123.9m ounces, followed by Mexico (104.7m) China (89.1m) and Australia (52.6m).

Nearly all of Australia’s silver production comes from BHP’s Cannington Mine in North West Queensland. Cannington is one of the world’s largest silver/lead mines. Pure silver mines are rare in Australia – most of the output is as a by-product of gold or base metal production.

Supplies of scrap silver accounted for 19% of global supply in 2009, or 165.7 million ounces, while government sales represented just 1%. Notably, supplies from both of these sources fell heavily in 2009 compared to 2008.

Silver demand is a more interesting and complex story. The chart below, taken from the Silver Institute, shows the various sources of demand for silver.

By far the largest source of demand is ‘Industrial Applications’. A funny thing happened to silver soon after its demonetisation process got underway; new technologies resulted in a massive increase in its usefulness for industry.

As a conductor of heat and electricity, silver’s qualities are unrivalled. Because it doesn’t corrode or overheat (and therefore cause fires) it is used for switches, contacts and fuses in nearly all electrical appliances, from households to industry. In addition, silver is used in computers, mobile phones and cars.

Silver also has anti-bacterial qualities. Thousands of years ago, water and wine were transported in silver vessels to ward off contamination. Now, the medical industry uses silver in a range of applications to speed healing and avoid infections.

Silver has many other industrial uses, including advanced technology, however we think you get the gist. Silver plays a critically important role in the modern economy.

As you can see from the chart, industrial applications account for a large portion of silver demand. In 2009, it represented 48% of total demand, or 352.2 million ounces. This represented a sharp fall from 2008 as the global recession took its toll. But as you can see, this didn’t really impact overall demand. We’ll look at the reason for that in a moment.

Other major areas of demand include jewellery, which is fairly constant (22% of 2009 total demand) and photography (11%). Silver nitrate was first used in the photographic industry in the 1800s and it became a major user of the metal throughout the 1900s. However, with the advent of digital photography demand from this field has waned over the past decade.

Silverware demand (as in, plates, cutlery etc) has been fairly steady over the past few years while demand for coins (representing 11% of 2009 total demand) has increased strongly. In 2006 coin demand soaked up 39.8m ounces of supply. In 2009 coins accounted for 78.7m ounces – a near doubling in 3 years.

Which brings us to one of the increasingly important aspects silver demand, investment demand. Note that investment demand and coin demand are counted separately. Here’s where things get interesting.

Investment demand – It’s ‘implied’

The Silver Institute (www.silverinstitute.org) tracks global silver supply and demand and you can find this data (going back to 2000) on their website. GFMS compiles the data. As you have seen, mine production and scrap sales dominate the supply side, while ‘fabrication’ (which includes the uses discussed above) dominates the demand side of the equation.

But these two sources do not equal out. GFMS have therefore created a category, ‘implied’ investment, to balance out global supply and demand.

From 2008 to 2009 this implied investment demand increased by a whopping 184%, from 48.2m ounces to 136.9m ounces. The creation of silver ETFs in 2006 is considered the primary reason behind the increase in silver investment demand.

But even a cursory glance at the numbers compiled by GFMS leads you to think that these numbers may be understated, perhaps significantly.

Why?

Well, the GMFS 2010 World Silver Survey shows that the total holdings of the world’s three largest silver ETFs were 385.8m ounces in April 2010. The first ETF, the US based ishares Silver Trust, trading under the symbol of SLV, started in 2006 while the other two kicked off about a year later.

So we can safely say these ETFs have created new silver demand of nearly 400m ounces since 2006. But if we look at the implied investment figures from 2006 (inclusive) investment demand totals only 271.1m ounces. That leaves a 100m plus ounce discrepancy and we haven’t even factored in sources of investment demand outside of the three big ETFs.

What’s Bear Stearns got to do with it?

Now you might not think that this discrepancy is a big deal until you consider another piece of information. Do you remember how Bear Stearns collapsed in 2008 and the Federal Reserve helped finance its takeover by JP Morgan?

It turns out that Bear Stearns held a massive short position in silver futures at the time. Being ’short’ a commodity or stock means you are betting on a fall in price. When prices rise, you lose. When they fall, you win.

The silver price was rising strongly at the same time as Bear Stearns was going down the gurgler (Feb/March 2008). Perhaps Bear was covering its shorts in an effort to stem losses? (Short covering can produce very strong price increases).

But JP Morgan soon took over Bear Stearns and assumed Bear’s short silver position. This did not become apparent until months later when newly released data showed that JP Morgan held the largest silver short position in the market.

At the time, prominent silver market analyst Ted Butler pointed out that one or two US banks (JP Morgan being one) were short a massive 169m ounces of silver. This constituted an unprecedented concentrated short position. It will come as no surprise then to see that the silver price collapsed as soon as JP Morgan took over the short position.

Is it possible that some investment banks are making up the difference between actual investment demand and available supply by taking short positions on the futures market? We think it is, especially if the silver ETFs don’t actually have all the physical metal they say they do and are instead gaining exposure via the futures market.

The physical and futures precious metals markets (gold and silver) are a byzantine world and one we don’t pretend to understand in full. But examining simple supply and demand data, it is hard to ignore that the recent increase in physical demand for silver, if sustained, could be very bullish for the price over the next few years.

Along with the big jump in demand for silver coins, the increase in investment demand suggests that silver is in the formative stages of being re-monetised. A global population suspicious of what governments will do to the value of their money in coming years is the driving force behind this remonetisation.

As we pointed out previously, silver’s role as money declined in the 19th century not because people decided voluntarily against using it, but because government’s around the world virtually took it out of circulation.

If this trend towards silver as money continues, and we think it will, the gold/silver ratio should improve in favour of silver. However it is a tad optimistic to think the ratio will get back to its historical norm of 15:1.

There is one other bullish aspect to the silver story – its price. If silver really was just an industrial metal and not in the process of re-monetisation, would it be trading close to its all time highs? No other industrial metal is.

Silver’s recent high occurred in early 2008 (as Bear Stearns was crumbling). From there it fell heavily. It is difficult to put this circa 50% fall entirely down to the global deleveraging cycle because the majority of it occurred a few months before the panic of 2008 set in. Something else was driving the price down…

After bottoming at around US$9 in late 2008, the silver price has rebounded strongly and is now trading just below US$19. If silver can sustain a break through the US$19 area, we reckon it will go on and record new highs in a matter of months.

There are no guarantees in investing. There are only probabilities. Weighing all the evidence though, we think it is probable that the silver price will move to the upside in the months ahead.

Greg Canavan
For Money Morning Australia

Editor’s Note: Greg Canavan is editor and publisher of Sound Money, Sound Investments, a weekly financial report devoted to unearthing great value investments amid today’s “money illusion” of fiat currency. For a four-week free trial of Greg’s service, go to Sound Money, Sound Investments

SO CASH-in-the-BANK remains the nearest thing to “risk-free” that the finance industry offers. But risk-free now means “sure-fire loss” thanks to sub-zero real rates of interest.

The longer that interest rates stay below inflation, the more people will be forced to take more risks to defend what money they’ve got – and one higher-risk choice is buying silver. It’s slowly becoming ever-more popular, at least amongst that handful of savers and investors who see tomorrow’s inflation in today’s monetary policy.

Here at BullionVault for instance, and over the last 12 months or so, we’ve had more than 250 customers ask when we’ll offer silver alongside our gold-dealing and ownership service. No other single comment or query from our 16,500 users comes close. So now, our new silver market means you can trade physical bullion – at live silver prices – and store it securely at low cost in specialist, private vaults outside the banking sector.

You can start with a free ounce of silver today, if you wish. Before you do though, just why might you want to buy, own and trade physical silver anyway?

The case for gold is and increasingly plain, as Société Générale strategist Dylan Grice notes in his much-quoted Popular Delusions this week.

Sub-zero real rates of interest, plus huge and irreversible government deficits – funded by central banks printing cash – make this rare, internationally recognized and tightly supplied monetary asset as highly appealing as a store of wealth as it has ever been through 7,000 years of known history.

Silver, on the other hand, was ousted by gold bullion as the world’s monetary anchor in the mid-to-late 19th century. But it remained a medium of exchange well into the 20th century, and long after gold had vanished from sight too, buried in central-bank vaults to be represented above-ground by paper notes only.

Because silver is more than 17 times as plentiful as gold in the earth’s crust, its use as money – both in coin and as a measure of value – is far more common in the historical archives as well. Whereas today, it holds much the same basic appeal as gold, but with four crucial twists:

#1. Gold/Silver Ratio
Historically (meaning from the dawn of recorded time to around 1900), one ounce of gold typically bought 15 or 16 ounces of silver, and pretty much everywhere in the world too. Today, that ratio stands at 65 times in the wholesale spot gold and silver bullion markets. (It’s very much worse again if you’re trading small bars and coins, thanks to dealer mark-ups and margins.) Many analysts and investors now expect the ratio to fall back towards its long-term mean, if not quite reach it. Even the 20th century average would see silver doubling in value against gold – which itself, of course, plenty of people now see going higher against the Dollar, Euro and Pound Sterling anyway.

#2. Consumption
Whereas pretty much all the gold ever mined in history is still available – closely guarded but ready-at-hand as jewelry, bars and coins – silver is somewhat closer to commodities like crude oil, soybeans or orange, in that it often vanishes in its use. Consumption rarely affects gold, but silver’s lower value means recycling and recovering it isn’t always economical. And because it tends to be a by-product of other mining operations (mostly gold or copper), rather than dug up for its own sake, analysts don’t see silver’s primary supply as responsive as gold or base metals to changes in price.

#3. Industrial Demand
Unlike gold, silver is predominantly used by industry today. So rather than offering deflation protection (as gold most recently did after the collapse of Lehman Bros.), silver is strictly inflation-friendly, with a number of fast-growing uses in both developed and emerging economies making it look very growth-friendly, too. Excluding silver investing demand, London’s VM Group analysts now forecast an additional 350 million ounces of annual silver demand by 2020 thanks to:

• RFID tags for stock control and ID cards are “taking over from bar codes”;
• Solar panels – forecast to grow by 20-40 times in 10 years;
• Wood preservatives to replace arsenic;
• Wound care & other medical use, food hygiene, and anti-odor textiles – because silver, a biocide, inhibits bacteria.

This growth might soon eat itself, of course, if industrial demand forces silver prices sharply higher. But VM’s forecast compares with total industrial demand of 450 million ounces in 2008, according to the mining-backed Silver Institute. Meaning the case for silver doesn’t rest solely on monetary chaos.

#4. Volatility
On average, and across the last 42 years, a 1% move in gold is matched by a 1.75% move in silver, both up and down. Anyone expecting strong gains in gold, in other words, should expect exaggerated gains in silver, but with greater risk. Just check the spike of January 1980 for proof. Gold prices tripled in the last 6 months of the preceding year, but silver prices rose 5.7 times over, peaking at $50 an ounce. The subsequent drop was just as severe, and much longer-lived.

What makes silver prices more volatile than gold? As US oil tycoons the Hunt brothers found when they very nearly cornered the world’s near-term silver supplies and forced that $50 peak 30 years ago, silver is a very much smaller market by value. The wholesale bullion market in London – heart of the world’s gold and silver trading – turns over 18 times as much money in gold as it does in silver each day. Physical demand each year, though nearly 8 times larger than gold by weight, is estimated to be worth barely 11% of global gold demand at $15.2 billion.

Moreover, within those annual figures, gold’s use as a store-of-value (meaning investment bars and coins, plus jewelry) accounts for 87% of annual demand according to the GFMS consultancy. In the silver market, only 35% of annual off-take goes to storing wealth (investment, jewelry, silverware). That makes silver much more dependent on industrial demand, and explains why – very occasionally – it more closely tracks movements in the price of copper than gold.

Still, investors aren’t (or shouldn’t be) looking for “diversification” when they add silver to their gold holdings. Not in the sense of diversification that your financial advisor would use, just before you remind how much you’re losing in the bank and how much you stand to lose on bonds should inflation take hold. The average daily correlation between gold and silver, right back to March 1968, has been +0.62 (rolling one-month basis). It would be +1.0 if they moved precisely in lock-step, and -1.0 if they moved precisely opposite. Gold’s correlation with US stocks over both the last 40 and 10 years, for comparison, is almost exactly zero. Gold’s famous correlation with the Euro has been +0.51 since the start of 2000. Whereas, during the bull market of the last 10 years, the statistical link between gold and silver has risen to average +0.68, and it’s stronger again at +0.77 for the last 5 years.

Silver, in short, tends to follow gold very closely – more closely than pretty much any pair of assets you can name over the long term – but with bells on. Risk-free it ain’t, but neither is cash-in-the-bank. The appeal of buying silver to profit from inflation looks set to gain ground.

You can start with a free ounce of silver here.

Adrian Ash
for Money Morning Australia

Adrian Ash is head of research at www.BullionVault.com

Silver Standard Resources Inc. report that the sale of the Silvertip Project to Silvercorp Metals Inc. closed on February 26, 2010.
Silver Standard was issued 1.2 million common shares of Silvercorp at a deemed price of $6.25 per common share, and received a cash payment of CDN$7.5 million, for total consideration of CDN$15 million for [...]

What about platinum? Have a look at the chart: the medium-term bullish trend in place since last November may above soon. A correction is expected.

Indeed, 11 months of up-trend have driven platinum price to a technical resistance that is likely to prevent a further rise. The historical high price (point A on the chart) posted in early March 2008 at $2,308 was followed by several months of correction and consolidation. The real plunge started at mid-July last year. In just 3 months, platinum prices fell from $2,059 to $752 (point B, down 63%).

Click to enlarge

A rebound was initiated in November. Some momentum built up and eventually generated a bullish trend. Two weeks ago, the price action failed to break above $1,350. This level corresponds to the 38.2% Fibonacci retracement of the decline occurred between extreme points A and B. It also corresponds to a previous intermediary support zone, where the price action had bounced back in August 2008 (point C). Previous supports often become new resistances. That’s why some profit-taking has been triggered at $1,350: it was a technical opportunity to reduce risk and lock in decent gains.

From $752 to $1,350, it means that platinum prices have already bounced by 79% since last November. According to several indicators (Relative Strength Index but also Chande Momentum Osicllator), an overbought configuration was obvious at mid-September. The upside is very limited and the risk is clearly downward. Yesterday the price closed at $1,300, but there is more to come before bull players will take the opportunity to re-enter long trades. Technically speaking, there is probably 15% more to correct before the price action reaches a support line.

This target at $1,100 corresponds to a previous support area where the price action bounced twice (points D and E) in May and July this year.