Examining Silver And Deflation

Silver and other precious metals just can’t seem to get a break. There are several reasons one can think of for their lackluster performance: 1) the supposed Fed taper 2) a skyrocketing stock market seemingly indicating all is well with the world, and 3) a sense that the US dollar represents the “cleanest dirty shirt,” as they say. When you add to this that commodity futures across the board are lower on the year, you get a sense that some sort of strong disinflation or deflation is in the cards.

Of course, if falling prices were occurring with a genuinely strong real economy, I might be inclined to agree that gold and silver are in deep trouble. However, when I look at the economic data globally, I actually see a re-emerging deflationary threat, one that could damage bank balance sheets and—if not handled properly—bring about a return of the headaches of the 2007-2009 period.

During those years, as you likely know, gold and silver remained among the best-performing asset classes. I might add that gold and silver also managed to hold much of their gains into 2009, even as the broader commodity complex (following oil’s lead) got absolutely crushed. This happened because gold and silver are recognized at least by some as money—not merely as commodities. This distinction is an important one and is part of the reason why foreign central banks continue to accumulate gold, by the way, even if that buying has slowed down this year.

If we think historically, even many mainstream economists understand gold and silver primarily as deflation hedges. Although the example of the 1970s is the most recent example of gold and silver as inflation hedges, throughout history, whenever a depression appeared, premiums for gold and silver coins increased above their fixed monetary value. This history is often forgotten by some, especially those who focus only on the fact that the precious metals trade as commodity futures, or financial assets, even as other market participants view gold and silver as real assets.

As my coin dealer once told me, “there is always money for gold and silver.” This is all the more true of silver (along with platinum and palladium) where above ground stocks could be easily purchased by a couple of billionaires. The only question is what the catalyst will be to send prices higher.

The release of the Fed’s minutes– and more importantly, the way that the market obsesses over these minutes– speaks to the importance of the FED in getting things right with a monetary policy that is the sole driver of this stock market led “recovery” — that really is not a recovery at all for most people. Even Ben Bernanke understands the role of FED credibility in maintaining strong asset values. But as we all learned in 2008, the FED is very much a human institution, often finding itself responding to crises that it never saw coming. In other words, you should be careful leaving the future of your savings entirely in the hands of experts who are no better able than you or I at times to manage the complexities of the global economy.

The deflationary threats still remain. Ask yourself, can the average consumer handle rising interest rates? Can bank balance sheets handle a further drop in housing values? On the other hand, will the FED be able to taper if it senses that the animal spirits on Wall Street are getting out of hand? At what point will the credibility of the FED, or other central banks, be questioned if there is a widespread acceptance of the idea of a liquidity trap? Isn’t a rising stock market without a strong real economy precisely the kind of situation we think about when we remember crashes like 1929? You get my point– it seems to me that a lot of people are making light of real challenges out there in the real economy.

Yes, broader commodities may continue their trend lower– and so might silver and gold for the next several months or a year. But always remember what sets the precious metals apart.

And also remember how few people—especially now—really own them.

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University of San Diego Lecturer
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ryanjordan@sandiego.edu