Sunday, June 8, 2014

The Appeal Of Holding Precious Metals When Cash Yields Are Negative

The announcement this week from the ECB (see Explaining What The ECB Did Yesterday) was centered around the news that they are bringing their deposit rates into negative territory. These negative rates apply to the bank deposits held at the ECB, not citizen's deposits held at the banks. However, citizens will end up paying this cost through higher fees charged for the "privilege" of keeping their savings in a bank account.

Their savings will be charged a negative interest rate indirectly. 

With 0.0% returns (or below) for holding your assets in safety (cash) in the United States, U.K., Japan and now Europe, citizens have been forced out into risk assets in order to obtain some form of yield through dividends (stocks) or interest (bonds). This has pushed the price of risk assets in the United States back into the over-valued/extreme positive sentiment territory last seen during 2007. See:

U.S. Stock Prices: How The Home Bias Phenomenon Impacts Investors

U.S. Stock Sentiment: Volatility Disappears Setting The Stage For A Cyclical Top

U.S. Bonds: The Danger Behind Purchasing Bonds At Peak Complacency

While the U.S. asset prices are perhaps the most extreme in terms of overvaluation (other than the ridiculous yields currently seen on Japanese government bonds), asset prices in Europe, the U.K. and Japan have seen an experienced a price levitation over the past 3 years.

The option for investors today is to either hold cash with no return or invest in risk assets and reach for yield. This is currently a no-brainer because investors have the psychological backdrop of three steady years of risk asset price appreciation. Holding money in cash seems ridiculous when you can receive a steady yield (2% to 4%) and a 30% plus increase in the asset price itself (seen in U.S. stocks in 2013).

However, what if the thought entered back into investors minds that there was even a possibility that risk assets would not move higher in a straight line upward forever and potentially had the chance to.......fall?

When assets fall in price the "no return" cash category begins to look extremely attractive. Found within this most hated cash group is precious metals, which are a cash alternative. It is possible investors will look to diversify into this group, even at a very small percentage, if they find out that they are being charged to hold their money in the bank. 

Precious metals have been falling in price for 3 years and sentiment is back at record lows. Last week the daily sentiment index reached 9% bullish on silver, meaning that 91% of traders believed the metal would fall lower from these prices. The index is now a mirror image of the sentiment readings when silver was surging upward in the $40 plus range in 2011 (silver is at $19 today).

An ounce of silver is currently at a price below the total cost to mine it out of the ground. New and planned production for mining of the metal has either been shut down or postponed. I believe that during the next paper asset price decline central banks will respond just as they have during the past six years; additional monetary easing and larger asset purchase programs. There will be a rush back to precious metals at a time when very little supply is entering the market (it takes years to bring a mine to production). 

Some see the recent price decline as the end of the secular bull market in precious metals. I see it as the perfect set up for the grand finale of the secular bull. Positive sentiment has been completely washed away and investors have liquidated out of their position. Supply has been cut back or shut off.

While the final bull market run in gold should be exciting, it will be the silver price rise that brings shock and awe to the masses.

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