Tuesday, May 04, 2010

Gold and Silver may be Great Investments.

Why You Must Buy Gold, or Even Better, Silver, Now

By Porter Stansberry
Thursday, August 10, 2006

Many investors believe that gold is a hedge against inflation. And, that’s true... but that’s not the real secret of gold...

The real purpose of gold is to hedge against government hubris.

I won’t get into a political analysis in today’s column – you get enough of that in the paper and on TV. But surely you can see that, around the world, the role of government is at the top of a huge period of expansion.

In Europe, governments have launched an enormous economic experiment: a paper currency that’s not even backed by a single political force. In the United States, the government believes it can spend money it doesn’t haveeternally without consequences.

In Latin America, two governments, Bolivia and Venezuela, have decided that they’re entitled to steal billions in assets from private investors, break contracts and takeover the most important sectors of their economies. In Russia, although it’s not really a break from the past, the government has stolen the biggest energy company and staged a show trial of its CEO.

And, perhaps most dangerously of all, governments around the world have promised their citizens a level of economic security in the form of pensions and health benefits that they cannot possibly afford.

Today, not very many people understand the fallacy of these actions... or their inevitable collapse. But... over time... more and more people will begin to doubt the solvency of their governments and the practicality of their schemes. If the government can’t pay its bills... why am I saving its dollars? If I can’t depend on the government to protect me and my family, how will I pay for protection... for health care... for energy...?

When people have tangible evidence that something has gone badly wrong with the economy, they begin to hedge against it. They hoard real assets. Rich people hoard gold and silver.

Hedging is like buying life insurance. You don’t buy life insurance as an investment, except maybe as a tax strategy... but that goes beyond this metaphor. In general terms, you buy insurance so that, if something terrible happens, your family will have something to live on. Likewise, you should have some exposure to gold and silver in your portfolio. And no, it’s not too late to buy some – far from it.

What you want in a hedge is a lot different than what you want in an investment. With an investment, you need something that’s stable, which hopefully provides a yield, and isn’t going to drive you crazy with volatility. Silver is none of these things. But it is a perfect hedge, because, when things go wrong economically – when there’s a crisis – the price of silver goes bananas.

Why? Because of the silver to gold ratio.

Historically the price of gold has been around 16 times the price of silver. So, for example, based on the long-term historical average ratio, with the price of gold around $650, the price of silver should be around $40. It’s not, of course. It’s around $12.50

Today then, the silver ratio is more like 50. What explains the difference between hundreds of years of history and today? Simple – demand for silver as money. During periods of history when silver has been used as a currency, it has almost always been valued ~ 1/16th the price of gold.

When silver has been “demonetized,” supplies soar as people sell silver for gold and currency. On the other hand, during periods of monetary crisis, the price of silver tends to increase far more than the price of gold as demand for silver is once again created by monetary needs.

This influences the silver to gold ratio heavily in silver’s favor. For example, the ratio returned to its historic range (16) during World War I. It happened again in the early 1970s when Nixon abandoned the gold standard. It also happened most famously in 1979/1980 when gold briefly soared to $800 an ounce and it seemed as if America was really entering a severe money crisis.

My friend and fellow newsletter writer, Chris Weber, wrote an outstanding report on the history of the silver/gold ratio in his April newsletter. I urge you to read it (www.weberglobal.net). I admit freely that Chris’s work has influenced my thinking; it’s not the first time. I’ve known Chris since the mid-1990s. No other general investor that I know, buying regular common stocks, has made more money investing and suffered so few losses in that time. I believe Chris Weber is the single best investor in the world. He’s long silver.

Silver is the best hedge against a money crisis because its price will increase many more times than gold, as the silver-to-gold ratio reverts to its historic average. Silver will once again be worth 1/16th the price of gold. It is now worth only about 1/48th.

Assuming gold hits my target of $2,000 an ounce; gold hoarders will have gained roughly three times their money, based on today’s $650 price of gold. But if you hedge with silver, you could make a lot more... $2,000 gold divided by the historic silver ratio of 16 sees the price of silver at $125 per ounce – roughly ten times the current price.

Given this perspective, I hope you see why silver’s recent move from around $7 to around $12.50 is only the very early signs of a money crisis. It’s going much, much higher.

Even if you think I’m nuts, it’s still a good idea to hedge your portfolio from the currency risks I believe are very real. You can do so easily and safely by taking a position in silver today.

Good investing,

Porter Stansberry

Editor's note: Porter Stansberry is a regular contributor to DailyWealth, a free investment newsletter focused on the world's best contrarian opportunities. We write with a simple belief in mind: You don't have to take big risks to make big money with your investments.

The price of gold today is at US$1,182.70 per ounce and that of silver is US$18.81 per ounce. Please note that the above article was written in August 2006. Thus, it looks like gold and silver are really on the way up. Will this uptrend continue? My opinion is: Yes.