Silver likely To continue to Outperform Gold

Gold and silver have been boosted higher during the last few years as a direct consequence of central banks actions. In particular, the Federal Reserve (FED) has been engaging in a prolonged quantitative easing program, buying billions of dollars in Treasuries & mortgage securities in a desperate attempt to put the US economy back on track again. In the process, this is debasing the US dollar and creating a positive landscape for precious metals to rise.

Gold has performed particularly well, rising 78% during the last three years, and silver has been even better with an appreciation of 111% during the same period. With the FED announcing what is now dubbed “QE Infinity” 2 weeks ago, we expect the metals to continue their uptrend. But, is gold due a rebound relative to silver, or will silver continue to outperform gold?

When central banks intervene in the economy by creating liquidity on a large scale, they do that in an attempt to boost the economy but, at the same time, they also boost inflation expectations as the ultimate effect of quantitative easing is inflation. Gold and silver are traditional hedges against inflation and tend so to go higher when inflation expectations rise. Now QE3 is to kick off in earnest, with $40 billion to be spent forever (as stated by the FED), the potential effect on precious metals is obvious. But the QE story doesn’t end with the Fed however as many other central banks are also expected to follow with monetary easing measures. That was the case for the ECB, for the BOJ, and Tuesday night for the RBA who cut their key rate from 3.50% to 3.25%. Other banks will certainly follow in an attempt to mitigate the US dollar depreciation as it negatively affects their export sector and can ruin their country. That’s one of the major problems for Japan right now.

For precious metal traders, this is an opportunity to add these metals to their portfolios as they will most likely do well under the current economic scenario. Investment banks have already upgraded prospects for gold, many believing it will reach $2,000 in the first half of 2013. Regarding silver, prospects are even shinier, according to the same analysts, as they see the metal touching its 2011 high at $48.44. Given yesterday’s close at $34.77, that represents a 40% upside potential.

The table below shows performance data for gold, silver, and the S&P 500 aswell as highlighting the quantitative easing programs unfolded by the FED.

We can silver tends to outperform gold during the quantitative easing programs. That happened during QE1 and QE2. The reason for this is that silver tends to be a better performer during risk-on rallies, when greed outpaces fear but, it is a poor performer when fear returns to the market.

Looking at the data, it seems that silver enjoys favourable conditions to continue to outperform gold whilst QE3 is unfolded and other central banks follow but, if the European crisis deteriorates once more and the risk-off mentality returns, traders will send the metal to the garbage very quickly. For now, prospects for silver to continue to outperform gold are good. We recommended a pairs trade in silver v gold in our September edition, page 90 (Link here – http://issuu.com/spreadbetmagazine/docs/spreadbet-magazine-v8_generic) and stick with this.

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