Arbitrage trading and spread trading is not without risks. Just ask those who decided in late-January that Brent Crude was widening out too much compared to historic spreads against West Texas Intermediate crude. That was a widow-maker. But take oil out of the equation and consider the two reserve currency metals of gold and silver.
The turmoil in the Middle East and North Africa has driven oil higher and has driven many wary investors back into the safety trade of gold and/or silver as the ultimate reserve currency. For US investors who are not worried about another meltdown that destroys the holders of their gold or silver, we generally default to iShares Silver Trust (NYSE: SLV) and SPDR Gold Shares (NYSE: GLD). If you want the comfort of physical silver rather than the “implied exposure” that the iShares Silver Trust (NYSE: SLV) offers, there is the direct silver exposure ETF that has lower share volume in the ETFS Physical Silver Shares (NYSE: SIVR).
Our technical analysis affiliate is Adam Hewison of INO and he is still sticking with his call in an audio/video presentation that gold could drop more than silver based on current trading ranges. We have some real doubts about the permanence of the new silver premium versus gold premium now that spreads have reached a historic tightness. Despite some personal disbelief or questions, he’s been right so far. After all, look at the silver versus gold ETF chart from CapitalIQ:
Now, forget about ETFs for a moment and go back to what made precious and semiprecious metals the reserve currency of choice in the first place. It was financial panic and the fear that either the economy was going to experience hyper-inflation or that the economy was going to suffer a systemic breakdown.
This one explanation here for the preference of silver over gold may be a simple one that we will dub “the barter economy trade.” It is not the only explanation for the disparity that has come about. Some of you may even disagree with the logic on the surface. If the world goes to hell in a hand basket where markets break down and the world has to temporarily go back on the barter system, then silver is better to have than gold at the street level. Forget about buying a seat to the few safe havens, think about “the Average Joe at the street level.” The logic is that gold has too much value for too small of a measurement size. Trading an ounce of silver for clean water or for a meal might not bee too unreasonable in “the barter economy trade.” With gold, the ounce has to be broken down into too small of units for the same.
Many nations where the turmoil is now has a citizenry that could not afford a single ounce of gold if they saved all of their discretionary cash for a year. While much has to be skipped in the explanation, that would put a premium on “the next best thing” and the next best thing would be silver.
As a reminder, if the true “barter economy trade” comes back into the minds, the ETF and exchange-traded products will not really work. If a meltdown occurs, it is completely unrealistic to assume that your counterparty holding the physical commodity or the contracts for the commodity will be there. The silver trade is winning so far. If that continues then it is potentially a sign of much worse things to come.
JON C. OGG