The right time to stock up on gold and silver equities

In these economically uncertain times, gold and silver are among the safe haven hedges for over-stretched financial markets.

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President Donald Trump is likely to be good news for gold prices if early indications are any guide. Not since the Brexit vote last summer has the outlook for the gold price looked so positive. Commodity prices are largely a function of supply and demand. Too little supply and the price goes up. Too little demand and the price goes down. And vice versa. Printing money is another factor that causes commodity prices to rise.

Today everybody in Abu Dhabi is talking about falling oil prices because of an oversupply in the global market, very slow economic growth and a recession in global trade. But the supply and demand position is very different for gold and silver.

Remember how when oil prices topped US$100-per-barrel there was much noise about “peak oil”, that is to say future oil supply had reached its limit and was on the way down? Well the same now applies to gold after recent cutbacks in exploration and mine investment.

Mining analysts say gold supply is set to shrink from the 30 tonnes once forecast to just 20 tonnes by 2025, a loss of one-third of projected supply. For gold prices that points only in one direction: up.

Why did investment and exploration in new gold mines slump in recent years? Well, that was a function of the 45 per cent fall in the price of gold from October 2011 to last December. Gold companies slashed investment and jobs in that period, just as the oil companies are doing this year. It’s a capital investment cycle, and the eventual impact of such capacity reduction is always higher prices. Mr Trump is another big uncertainty for markets, and he won’t even take over as president until late January.

For the investor, the art is to position your own investment to catch a time when a commodity price is still relatively low, just as a supply shortage becomes evident and demand begins to increase. Oil will get there. But gold and silver are already in this happy position.

So why should we be optimistic now about a demand-side boost for the gold price? I ask readers to just cast their eyes over the financial pages of any newspaper or website. Do global equity markets not look close to record highs at a time when the global economy is moving at the speed of a snail, if not one that has been trodden on?

Do global bond markets not keep you awake at night with lows not seen in decades for yields and enormously inflated bond values? And the more than doubling of yields on long-term bonds this year points in only one direction. The only thing we can really be certain about is uncertainty, and nobody would argue with the idea that financial markets hate uncertainty.

Sure, the central banks are holding the dysfunctional global financial system together with money printing and multiple policy tricks. But this is an illusion that could slip at any time.

What are the classic safe haven hedges for overstretched global financial markets? And there are now very few analysts who argue that they are anything else. US dollars, Japanese yen, gold and silver, short positions in major stocks and indexes. It is not a very long list of options. The logical thing to do is to seek out bargains, basically what seems to be selling at the biggest discount to other assets. That would remove the US dollar, whose key index is trading close to an all-time high of 100. You might also wonder how an economy as overstretched as Japan is supposed to support a strong currency. Therefore in terms of currency you are back with the oldest of all, the only monetary metals, gold and silver. Both are still priced way below their 2011 highs with an excellent prospect of a massive snapback.

To be really intelligent you should leverage up on the precious metals. It’s possible to do this either by borrowing money to invest or by trading options. But the lowest risk method is simply to buy the equities of gold and silver producers and exploration companies. This works because as the price of gold and silver rises, the profits of these companies increase by even more. Basically they have their fixed costs and then the gold price increase is pure accelerated profit growth, which boosts their share price.

There are some well-established exchange traded funds that spread your money among a basket of industry leaders at low cost. Consider the GDX for gold producers or SIL for silver-related companies, or for potentially higher gains buy the junior companies in the sectors with GDXJ and SILJ, respectively.

I tipped SILJ earlier this year in this column and it is up more than 200 per cent year-to-date.

Peter Cooper has been a financial journalist in the Gulf for the past two decades

business@thenational.ae

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