By Martin Tillier
For silver buyers the chance of further Fed action, and the reasons it may or may not happen, represents a unique opportunity.
Unheard of a few years ago, QE, or Quantitative Easing, has become part of the everyday lexicon of investors. It is the Federal Reserve’s chosen method of injecting liquidity into the economy, or to put it more bluntly, printing money. Under QE the Fed buys Government bonds (Treasuries) from the banks that hold them. From the perspective of stimulating the economy, this has two desirable effects.
Theoretical effects of QE
Firstly, the central bank’s presence in the market forces the price of treasuries up. In bonds, price and yield have an inverse relationship; as prices go up, interest rates go down. Treasuries are the benchmark by which all other interest rates are judged, so lower rates on Treasuries means lower rates in general. Lower interest rates make it less expensive for borrowers to borrow, and, in the case of businesses, makes it more likely that an investment using borrowed funds will be profitable. In other words, QE encourages borrowers to borrow.
The second effect is on the lenders (banks and financial institutions). They owned Treasuries in the first place as a way of getting a return (interest) on their money. Now that those bonds have been bought from them they are left with lots of cash that their business model demands they invest for a return. In other words, QE encourages lenders to lend.
Real effects of QE
Leaving aside the desirability of the Federal Reserve encouraging another credit bubble, there are some practical problems with the policy. The crash of 2007/8 wasn’t a normal recession. It was a credit crisis, and the hangover from that mutes the effects of any QE. Most potential borrowers have a new understanding of the dangers of debt and an understandable reluctance to take more on board. From the lenders’ perspective the lessons are equally well learned. Gone are the days when the qualification standard for loans was that you had a pulse. Lenders’ standards are tighter, just as the number of qualified and willing borrowers is decreased.
QE resulted in money sloshing around the financial institutions, though, and it had to go somewhere. The stock market seemed like a logical place, so, while the Fed’s actions had little noticeable effect on unemployment or consumer spending, even the rumor of a further round of QE causes the stock market to spike. Despite the muted effects of QEs 1 & 2, it appears that the Fed is considering another round, the infamous QE3. It is this that represents a unique opportunity for silver buyers.
Built In Hedge
The industrial uses of silver mean that an improving world economy, and the resulting increase in demand, is supportive of the price of the white metal. So surely, if things get worse the price of silver will fall? Not necessarily.
In the event that either the global or U.S. economy falters, the Fed has suggested that they would respond with increased liquidity (read as printing more money). Simple supply and demand dictates that if there is a greater supply of dollars the value of anything priced in dollars, such as silver, must go up.
Win, Win, Win…..
You may believe the Fed’s past and possible future actions are a good thing, providing a measured stimulus to tweak demand and avert the dreaded double dip. Or you may believe that they are a bad thing, creating another credit bubble and the specter of inflation. You may even believe that, good or bad, the Fed should not be distorting the market in any way. Whatever your political view, you can still position yourself to profit.
Allocating a portion of your portfolio to silver is a win, win, win scenario for investors.
Win: In the event that things continue to improve, industrial demand will provide support.
Win: If demand falters the Fed will step in and provide a form of assistance that will, regardless of its effectiveness, put upward pressure on silver prices.
Win: If the long term consequences of intervention are disastrous, leading to hyper- inflation and a collapse in confidence in the US dollar, then silver bullion’s status as a store of physical value comes into play.
In short, if the Government, in the shape of the Federal Reserve, is prepared to offer a free insurance policy for an investment, it makes sense to grab it with both hands. Silver bullion, due to a unique set of circumstances, is that investment.