Emerging inflation underpins gold and silver price rises

When, on the first day of trading in New York for 2021, gold initially climbed US$50 per ounce (A$65/oz) above its previous close, opinion was divided as to the cause of its (and silver’s) burst upwards.

Silver was up US$0.87 (A$1.10) at the Comex open on Monday, also a healthy jump.

Gold decoupling from equities was one opinion. Fear of reinflation another. General concern about the global economy and an equity market crash, another.

Jeremy Grantham, co-founder of Boston-based investment firm GMO and almost always described as a “legendary investor”, began the new year with a warning.

“The long, long bull market since 2009 has finally matured into a fully-fledged epic bubble,” he wrote.

“Featuring extreme overvaluation, explosive price increases, frenzied issuance, and hysterically speculative investor behaviour, I believe this event will be recorded as one of the great bubbles of financial history, right along with the South Sea bubble, 1929, and 2000.”

Put that together with Alan Greenspan’s oft-quoted remark — “In the absence of the gold standard, there is no way to protect savings from confiscation through inflation” — and you have one answer for the new spike in gold and silver.

And inflation or reflation are terms now on many lips.

What is remarkable is that this rebound in both precious metals is coming just weeks after they had been knocked to the mat and the referee was about to count “eight and out” in the view of some commentators.

We’ll come back to that, but a quick silver diversion.

Silver forecast to hit US$40/oz in 2021

At the same time, the gold-to-silver ratio has been under the spotlight.

As this is written, the ratio still stubbornly clings above 1:70.

However, this week The Silver Manifesto author David Morgan, who also runs a widely read online newsletter, sees silver hitting US$40/oz (A$51/oz) this year. This is not the return to US$50/oz (A$65/oz) that the silver bugs yearn for, but if achieved, it is likely to rebalance the ratio with gold by quite an extent.

A US$40/oz price would mean a 45% gain — and no one is suggesting gold will see that sort of action this year.

Mr Morgan argues it will be the demand for silver from makers of solar panels, combined with its safe haven status as a precious metal, that will do the trick.

“The amount of silver that has been purchased by the funds [was] 300 million ounces of physical silver. This is totally unheard of. We’ve never had that kind of investment demand in silver in decades,” he said.

Still, 1:70 is a lot better than the 1:128 ratio which occurred in the silver market last year.

Plus, the ratio is at its lowest in several years, and remember, it poked its head above 1:90 in mid-2019.

London-based Hallgarten & Co principal and mining strategist Christopher Ecclestone sees the ratio continuing to rebalance in silver’s favour over the next two years.

“One is more likely to see silver in the high US$30s than one is to see gold at over US$2,500/oz in the next twelve months,” he said this week.

Inflation, gold’s best friend, is lurking

Reflation fear is back.

Bond dealers in New York were bullish as 2021 kicked off with the expectation that vaccine roll-outs would see a swift US economic recovery, and the wire services reporting companies seen as “reflation plays”.

The team at Liechtenstein investment firm Incrementum are convinced we are on the brink of an inflation wave.

They point out that Richard Nixon’s 1971 decoupling of the greenback from gold had one, huge unintended consequence.

It transformed the American economy from a metal-backed (as in gold) regime to a debt-backed one.

In just one month — June 2020 — the US created new debt not too far off the level created in the first 200 years of the republic.

Between 1776 and 1976, the American government raised about US$1 trillion in total. In June last year, the debt blew out another US$864 billion (A$1.11 trillion) in just 30 days.

Total credit market debt in the US was at US$1.6 trillion in 1980.

Last year, it reached U$80 trillion (A$103.2 trillion).

The US budget deficit hit US$3.3 trillion (A$4.2 trillion) last year, triple the amount added in 2019.

Gold considered best portfolio investment

Incrementum, which publishes the much-read annual In Gold We Trust report, sees inflation washing through commodities, with other commodities following gold’s trajectory through what it sees as the new inflationary period.

Even agriculture commodities are on the move, with rising interest in soybean futures in particular.

Gold, Incrementum adds, will be the central and primary store of value during this cycle. The firm has also been bullish on silver.

“Gold’s function as a hedge against inflation and tail events may turn out to be the best component of one’s portfolio in the coming years,” the firm’s recent inflation alert report reads.

“Gold’s robustness against uncertainty is also attributable to the sheer number of historical events it has survived and institutions it has survived.

“Gold has been around as a currency for thousands of years and is one of the oldest cultural institutions.”

Gold miners

But what about the gold mining sector as opposed to the metal they produce, or for which they explore?

This writer was charting gold’s rise from the early 2000s and two things were noticeable.

One, the share prices of the gold companies, particularly the producers, for several years lagged the rise in the metal’s price.

Two, very few big investors or institutions were interested in the sector.

Indeed, several Australian brokers had got rid of their gold analysts by that time due to the gold malaise of the 1990s.

So, there were not that many analysts interested or knowledgeable about the sector — it was left to Angus Geddes at what was then an upstart investment firm, Fat Prophets, to make an early call that the metal was on its way to US$1,000/oz.

Fortunately, Australia is now better served in terms of gold research and institutions have been ready suppliers of investment cash to the sector in 2020.

Now, too, it seems to be the gold shares that are setting the pace with good drilling results and discoveries setting fire to individual stock prices.

Fund managers ‘miseducated’ about gold

But, apparently, the new interest in gold is not the case everywhere.

Well-known US gold pundit Doug Casey said recently that fund managers have been “miseducated” about gold since university and that gold stocks are not even on the radar of most institutional investors.

“These gold mining companies are coining money at this point, and eventually [the fund managers are] going to figure it out, and they’re going to pile into them,” he added.

Casey also made the point that the gold mining sector’s entire market capitalisation is lower than Apple’s cash reserve.

And the point follows that the value of the primary silver producers is even far less.

Limits on metal production — but not on fiat money

There are impediments to getting one’s hands on all the gold and silver you want.

Gold production has been increasing only modestly of late — not like iron ore, for example, where production can be cranked up to meet demand in a relatively short period of time.

There is no such thing as a gold surplus.

Silver supply is heavily reliant on the by-product availability. That supply drops when base metal miners shutter or reduce production when the price of their primary metal falls.

By contrast, central banks can create “wealth” at will.

As the Incrementum team points out, the cost of creating €100 digitally is the same as creating €10.

But there is a world of cost difference between mining 10oz and 100oz of either gold or silver.