Why Debt Destruction Is Bad For Silver And Gold But Neutral For Equities

Includes: GLD, SLV
by: George Kesarios

The Cyprus issue has opened Pandora's box some say. Now that Europeans are afraid of losing their deposits, Gold (NYSEARCA:GLD) and Silver (NYSEARCA:SLV) - - among other "hard" assets - - will be the beneficiary of this turmoil, as more and more people will look for a safe haven.

Well if this is so, gold and silver should be rallying right? Well I have news for those who think that gold will be the beneficiary of this crisis - both gold and silver so far have not rallied. Also, gold and silver will not be a beneficiary of this crisis but will probably break down and go to lower levels like I have said in past here and here.

Let's see the chart below of what gold and Silver has done the past few two weeks while this crisis was unfolding.

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As you can see, both gold and silver have not rallied -- in fact silver is even lower.

One explanation for this that openly contradicts the main reason to buy gold and silver is that we are not experiencing any sort of inflation like the precious metal crowd says. A second reason is that we are in a deflationary asset cycle, like I have talked about in previous posts.

As I see it, in order for the European crisis to come to an end, about 2-4 trillion euros worth of debt will have to be wiped off country and bank balance sheets. This actually means less money to go around. And this means monetary deflation.

So what actually happens in periods of monetary deflation? Well we have less money to go around. Think of it like this: In periods of inflation we have money chasing goods, but in deflationary periods, we have goods (or assets) chasing money.

So if we see debt destruction on the scale that I think we will see in Europe, both gold and silver will not go up, but down.

Does this also apply to equities? Yes it does, however there is a catch.

See, stocks like Microsoft (NASDAQ:MSFT), Apple (NASDAQ:AAPL) and Intel (NASDAQ:INTC) have a forward P/E of about 10 or less. In other words, these stocks have become cheap because their fundamentals have improved, but their stock prices have stayed the same on a nominal basis.

In other words, they have also taken a hit, but fundamentally not nominally.

And that's the reason why I have said many times that current equity valuations are cheap and will not correct, even in a scenario of a fiscal cliff trigger (please consider: The Fiscal Cliff Is Already Priced In).

But as for gold and silver, we can not put a forward P/E on them or use many other metrics to determine their value as we do with equities. We can only use some sort of relational chart to see where we stand, or else value gold and silver on a pure nominal basis.

Bottom line

We have been in a deflationary asset cycle for some time now.

While all assets are generally affected, equities today are not expensive. Especially as per global large cap names are concerned, their fundamentals have generally improved but have not risen nominally and thus have actually become cheap in terms of value.

Gold and silver however are not dynamic investments like equities, and their value is determined on a purely (mostly) nominal basis.

For long term conservative investors, I continue to advise selling gold and silver, including gold stocks (my take on those here) and stick to high quality global equities that have a relatively good P/E ratio (below 14) that also pay a dividend above 2%.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.