Precious metals was one of the few asset classes that performed well last week as a plethora of concerns stalled stocks — earthquakes, tsunamis, a government shutdown, Portugal’s bailout request, and surging oil prices.
Mainly, the rise in gold and silver is being driven by an increase in inflation expectations — which have returned to their early March peaks. Long-term interest rates are already increasing to reflect this.
There’s a currency component at work too as the U.S. dollar continues its downfall. Some of this is due to the malignant neglect of the currency at the hands of the Federal Reserve. With the European Central Bank joining monetary authorities in places like China and Brazil and embarking on an anti-inflation rate hiking campaign, only the Fed and the Bank of Japan are left sitting still.
Investors are moving cash out of the dollar and into foreign denominated assets like Brazilian bonds or Indian equities, further precipitating the greenback’s fall.
Finally, there is the looming fight over the U.S. Treasury debt ceiling set to be reached by the end of May. The fight over the fiscal 2011 budget shows that Democrats and Republicans remain far apart on critical spending issues. A failure to raise the debt ceiling would ignite financial panic and result in a de facto debt default by the U.S. government. Bad news.
While members of both political parties seem to understand the risks of inaction, the market is already pricing in trouble. U.S. credit default swaps are up nearly 12%.
So what are investors to do? Both major gold and silver commodity ETFs — iShares Silver Trust (NYSE: SLV) and the Gold SPDR (NYSE: GLD) — initiated technical breakouts earlier in the week and gapped up on Friday. Meanwhile, precious metal mining ETFs, including the Market Vector Gold Miners (NYSE: GDX) and the Global X Silver Miners (NYSE: SIL), are just now breaking through overhead resistance from prior highs. The Market Vector Junior Gold Miners (NYSE: GDXJ), which invests in smaller mining companies, also looks attractive.
On a relative basis, precious metal mining stocks have lagged the year-to-date performance of precious metal commodities — but they’re quickly making up for lost time.
It’s worth remembering that over the long-term, commodity stocks (and the ETFs tied to them) outperform commodities because they reflect the value of human ingenuity. That’s the idea expressed by Soc Gen strategist Dylan Grice. And it’s because higher prices for gold and silver will only encourage people to work harder to find new sources of ore and extract them from the earth.
As a result, gold and silver prices — although subject to large price swings — have largely flat lined when taking inflation into account. Stocks, on the other hand, have massively outperformed as shown in the chart above.
A combination of short-term strength and long-term bona fides makes a strong case for ETFs like SIL and GDX. I recommended SIL to my newsletter subscribers earlier this week — and still think it’s attractive at current levels.
Disclosure: Anthony has recommended SIL to his newsletter subscribers.
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