Will gold and silver hedge against global capital market declines?

The recent rally of gold and silver has surprised some technical analysts who contend that precious metals entered a bear phase last summer that will not be played out until gold is at least below $500 an ounce again.

It is perfectly possible for fundamental analysts to provide a set of circumstances in which this technical view is proven correct. If global capital markets were to undergo a significant correction, and the length of the current rally alone suggests it can not be far away, then a vortex of market selling might well drag down precious metal prices with no discrimination in the selling pressure.

Such a major shift in capital markets would almost certainly produce a rally in the US dollar, with a flight to safety and a swapping of equities for cash. This would be gold and silver negative.

Market outperformance

Yet the contrarian view is that gold and silver would outperform most other asset classes in a downturn, and therefore continue to perform well relative to the alternatives. So there is reason enough to sell precious metals last in a portfolio implosion and not to reach immediately for the sell button.

Why such confidence about gold and silver? Quite simply we can be even more confident about the reaction of the Federal Reserve to any significant capital market shake out. Interest rates would be cut to boost the money supply and support the markets.

Unfortunately, increasing the money supply is bad for inflation, and this will be the perception by the markets even if it was to prove untrue, and this is highly positive for gold and silver prices. The two metals should be spoken of together, although the closing of the gap between the relative prices of gold and silver does tend to favor silver investments above gold.

IMF rule changes

What if the Goldilocks economy continues in the US and we have entered some sort of new era of permanent prosperity? Even then precious metals look a long-term winner with price rigging by the central banks now being challenged by new International Monetary Fund draft rules on inter-bank deals.

For gold is still cheaper than it was in 1980, and has not shown anything like the recent price increases of many other metals. Remove the cartel-style manipulation of prices and there is a considerable upside, quite removed from economic circumstances.

Deutsche Bank told its clients that if you do anything this year, buy some gold and as a two-way hedge you probably can not do better. The only problem could be a blip in the price if global capital markets undergo a significant correction, but that might also be the last major buying opportunity.