How to Profit from Gold and Silver?
Gold and silver as commodities are valuable metals that are used as a medium of exchange in the ancient times. The common knowledge about precious metals is that they are commodities in limited amounts, can be used as a hedge against inflation as well as a safe haven that rises in value whenever there is chaos and trouble in this world.
Daily Chart of Gold
However, in the wake of the dramatic fall in value of gold in the past 3 years, gold and silver has become rather unpopular amongst retail investors. On September 7, 2011, Gold touched an intraday high of $ 1923.70 and has never seen that level ever since. Since then it has been on a spiral downtrend towards the $1100 levels, suppressed by all the major banks. That is 43% correction in price, which requires a 73% increase in price to bring it back up to that levels again.
The Bigger Picture
The huge question is always, so where is the bottom for gold? When is the right time to start buying again?
Weekly Chart of Gold
No one can tell for sure that where the bottom is, but if one were to invest in such opportunities, we should be looking at the weekly chart. Clearly, downtrend recently, and the bigger picture is still an uptrend. This is due to the gold properties as a hedge against inflation.
Based on a weekly technical analysis, it seems like gold is about to turn. It is at a key Fibonacci level of 50% retracement. However, to invest in the longer term, you need much conviction and much more evidence.
Why will Gold and Silver rise dramatically?
- The contrarian investor point of view
When was the last time we had a severe market decline that was all over the news? Yes you are right, 2008. Today we are standing at 2014, nearly 6 years from the last demise.
Economic cycle of boom and bust is only going to get shorter and shorter. And it seems that the average cycle now, has been reduced from 8 to 10 years to 6-8 years. The next crisis will come and when it does, gold will rocket due to its cheap evaluation.
- The cost of mining gold
According to Thomson Reuters Data, the average cost of mining and producing gold bars is about $1200 per ounce. Should the price remain suppressed below this price by the big players any further, the gold mining industry will become unprofitable.
The consequence will be that production cutbacks are likely. This is a basic question of supply and demand. The reduction in supply will increase the price. Furthermore, when the next crisis arrives, the demand will surge, further stating the fact that gold is approaching a bottom.
- Dirty cheap valuations
Calculating the P/E ratio for a commodity sector like this is rather difficult as gold itself does not have any earnings.
A better representative measure is the P/B ratio, which measures the sector’s stock market value against the book value of mining company assets. Since the profitability of the gold miners depends on the price of the precious metal, the current net asset value are actually -14% below where they were in August 2012. Furthermore, the sector trades at just 1.74X book value, near multi-year lows and a hefty 31% discount to the long term historical average of 2.5X, suggesting that the global mining sector remains undervalued at this juncture.
The Silver lining
Below are my reasons why Sliver will become an even bigger winner.
- Silver is a precious metal that is highly versatile. Silver’s demands in technological and medical uses stems from its unique anti-microbial, reflective and conductive qualities, making it a vital element in many high ticket projects.
Since it is so vital and used in such small quantities, its price is inelastic. If silver goes to a $500 a troy ounce and Apple Computer needs a 1/10 of an ounce to make their $1,000 computer work at the highest quality, they will simply raise the price $50 to make up the difference.
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Silver is cheap such that even the common man, with little savings can buy an ounce. When the next commodities rush comes in, everyone will want a piece, and silver will become hot in demand. The higher the price of gold goes, the more demand will naturally flow into silver.
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There is not much silver left in this world. While gold has been on everyone’s mind, silver is mostly used for the less eye catching sectors like medical and computers. Hence, much of the silver is not recycled, but rather wasted and thrown away. It is estimated that there is not much stockpile of silver left on earth, hence when the demand comes in, the price will shoot up like crazy.
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Comparing the silver market with the gold market, is like comparing the volume of STI to S&P500. Just as huge funds tend to buy stocks in S&P500, central banks are only buying gold. If they dumped a billion into silver, they would explode the market. A billion into gold would hardly make a ripple. When the time comes when paper assets are worth much less then it is today, silver will be the next best alternative for the big boys, and you will know what happen. J
Conclusion
While this is a low trade risk, it does not mean that gold and silver cannot go any lower. It seems to be a ‘right’ time to buy gold and silver because of multiple factors discussed earlier, and low risk trades are good trades to take. However, one should not be greedy and go on margin, because we never know how long the big boys can suppress the gold and silver market.
Actions to take now include buying some physical gold and silver or we can buy a precious metals fund (fundsupermart.com) or ETF. I would personally prefer ETF. This cannot, and should not be a margin trade, unless you are willing to buy again and again on margin, which is very scary and risky. This does not suit my appetite.
Disclaimer: This is just my recommendation and there are always risk to any form of investment. I will not take responsibility if you were to lose money in this trade.
