Dear Reader,
A few weeks ago, I was listening to an earnings call where both management and the analysts were concerned with higher commodity prices. The analysts’ wording revealed their projections. No one asked about the company’s reaction “if” commodity prices went higher, but rather “with” higher prices, what will management do.
But the conference call isn’t unique; it seems that everyone expects higher prices. In my JHU finance night classes, the professors have been warning of rising inflation, and most of the students are convinced too. Furthermore, editorial after editorial warns of the same problem. Though our inflation rate is still low, the level of concern out there is very high.
We’re not in the same place as last year. Back then, many warned of oncoming inflation, but the deflation side had plenty of supporters too – today it’s rare to find differing opinions. Disagreement instead focuses on how much inflation will there be when it surfaces.
Given the growing consensus on inflation, why aren’t Treasury yields higher? Well, maybe they would be without QEII. While QEII seems to be rather ineffective at pushing rates downward with the 30-year yield at 4.71% and the 10-year yield at 3.58%, there could be a lot of counterfactual information missing from this analysis.
It’s hard to explain how so many people have accepted the idea of future inflation, yet these expectations should not be reflected in today’s Treasury prices. Only an outside force such as the Fed can temporarily suppress rates from the market’s desired direction. Without QEII, 30-year Treasuries might have already been near 6% and 10-year around 4.50%. On the surface, QEII seems to have failed in its goals, but considering what rates might have been reveals a different angle.
In a way, this is a chicken-and-egg question. Did rates and inflation expectations slowly begin to rise due to QEII, or was QEII started due to fears of rising rates anyway? We can’t know for sure whether the first signs of inflation are the result of QEII or the past actions filtering through the system.
If the above scenario is correct, the Fed might have a tough time unwinding QEII. In June, we could see a large spike in rates as the Fed pressure lets up. For those interested in betting on rising rates, check out The Casey Report.
First, Jeff Clark will outline the reasons to buy silver even at $30. And with a high price tag, it’s definitely helpful to read his article. I began purchasing silver around the $10-$12 range, and $30 gives me sticker shock. I can only imagine how readers who bought in the low single digits feel. After Jeff’s article, I’ll have a few charts on price increases.
Jeff Clark, BIG GOLD
The silver price has bounced 15.3% since January 28, a strong advance for a measly 13 trading days. It’s already inched past its 2010 high and was selling for less than $16 this time last year, a near double in 12 months. So, is it pricy? Or should we ignore the run-up and keep buying?
I’ve read a few articles that say we should expect silver to drop to the $25 level, and one pinpointed $22. Others, of course, see bullish tea leaves for the near term and believe it’s headed higher. Of those that assert silver will decline, most believe it will be temporary, though one writer claims the bull market in precious metals is over (I think he’s a holdout from the gold-is-a-bubble camp).
These authors could be right about a near-term decline, but I’m less concerned with what the price does this month or even the next few months, and more focused on where it’s likely headed over the next few years. Caution: the chart ahead may cause excitement.
While there are lots of reasons to be bullish on silver, what everyone really wants to know is how high the price can go. Here’s one hint, based strictly on historical price performance.
Silver rose an incredible 3,646% from the November 1971 low of $1.32 to its January 21, 1980 high of $49.45 (London PM fix prices). Our current advance, through February 4, is 596%. At $30, silver would have to climb over five times to match the last great bull market. If it did, the price would hit $160.89 per ounce (from its bottom of $4.295 on March 30, 2001).
You’ll also notice silver has a record of outperforming gold in these two bull markets. In spite of the price dropping 26.9% in 2008 (while gold gained 5%), the metal has outrun its yellow cousin by 38.6% since their respective lows in 2001.
Gold advanced 2,333% in the 1970s; it’s currently up 430%. If it matched the last run, the price would hit $6,227.26 per ounce, a return of four-and-a-half times the gold you buy today.
From solely a historical price perspective, the chart certainly suggests we’ve got a long way to go with both metals. The question is if the fundamentals support such price advances (show me a healthy dollar and no threat of inflation, and we’ll talk), but my point for the moment is that there is an established precedence for the price of these metals to climb much higher. And just as important, to keep one’s eye on the big picture.
So, yes, I’m buying silver at $30, in part because I think the potential for enormous gains is high.
However, I’ll add that I’m not draining my cash account to do so. I think it’s important for the precious metals investor to always be in the game, but given silver’s volatility and the precarious nature of most markets right now, prudence suggests we keep some powder dry as well.
Let’s say one of the soothsayers noted above is correct and silver temporarily falls to $25. If you snag it at that level, your endgame return would be 543%, vs. the 436% gain from $30 (excluding premiums and storage costs). That’s more than another 100% gain on your original investment.
But how does one buy silver not knowing if the price will plummet or soar? For example, silver could take off from these levels, never to see $30 again, leaving those of you waiting for a sell-off out of the market. Or it could sink to $25, making investors who went all in now regret they didn’t wait for a better price. Or it could trade sideways until, say, next fall, leaving both parties uncertain and on the sidelines.
In my opinion, there’s a one-word answer to the question. It solves all dilemmas – it keeps you in the market, while simultaneously letting you buy at lower prices if that occurs. It lets you build your position bigger and bigger without the worry of whether you’re getting a good price.
That one-word verb is, accumulate. Or in the vernacular made popular in the ‘80s by the financial planning community, dollar cost average. In other words, buy a little now, buy a little next month, etc., until you have a position sufficient in size to fight off inflation and any other economic woe we’re likely to encounter over the next few years.
So my advice is, buy, hold, repeat. Because if our silver market ends up looking anything like that left bar in the chart, you may regret not having bought at $30, too.
[By the way, we updated the numbers on the market cap for Pan American Silver from our article last week… check out how tiny one of the largest silver producers is compared to other popular stocks here.]
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By Vedran Vuk
As most readers have probably heard by now, January inflation increased by more than expected at 0.4% from the previous month. Rather than focus on the big number, I investigated a few of the smaller categories in the BLS data, particularly in foods affected by commodity prices. One item immediately jumped out – the fats and oils category. Since last month, seasonally adjusted prices in this category increased by 2.1% – that’s enormous. Since soybeans are a crucial ingredient to vegetable oil, this spike is fairly easy to explain.
Let’s take a look at a few more categories in the data. Remember, the charts below are consumer prices. Coffee is a good start. Since last year, the price has increased by 15.9% from $3.81 per lb of ground coffee to $4.42 per lb. (For some reason, the coffee data had a large gap in 2009; as a result the chart begins in 2010.)
Next, let’s take a look at sugar prices per lb. Since 2007, sugar has risen 25.6% from $0.52 per lb to $0.65 per lb.
The last chart shows soft margarine prices. Again, since vegetable oil is a part of margarine, the price will necessarily be affected by spikes in the soybean market. Since 2007, the price has increased by 50% from $1.15 per lb to $1.72 per lb.
Hedgers are a big reason why consumer prices lag the commodity market. Major companies have already locked in their purchases and prices months ahead in the futures market, so they can delay price increases.
The second factor is the elasticity of the products. That’s a fancy economics term for the change in demand in response to a change in price. When a product is inelastic, demand changes little with a change in price. A good example is coffee. Most coffee drinkers do not alter their consumption based on price fluctuations. Of course, companies have calculated the elasticity of their products. Since inelastic products are less responsive to price, hedging departments pay less attention to covering these costs. For example, coffee prices can be easily passed down to consumers (as a rule of thumb, the more elastic a product, the bigger the hedges). Hence, elasticity can be a good predictor of how quickly consumers will feel the impact of spikes in the commodity markets.
There’s one more thing left before we wrap up today. Jeff Clark’s article from last week has been updated due to an error in the market cap for Pan American Silver. With the error fixed, his point is actually stronger than before the update. We’d like to thank our vigilant readers for catching the mistake. Here is the link to the piece.
That’s it for today. Thanks for reading and subscribing to Casey’s Daily Dispatch.
Vedran Vuk
Casey's Daily Dispatch Editor