The recent and rather significant drop in commodity prices has led many to wonder if this makes an attractive entry point, or is it beginning of a larger, more significant sell off. In this article, I will focus on two precious metals, gold and silver and their future prospects and how to trade it.
Reasons for the Sell-off
I haven't read many valid reasons that justify the recent sel loff. Some of the reasons discussed have been an unloading of gold reserves by Cyprus to fund the bailout as well as a general shift from commodities to equities and bonds in addition to Japan's latest monetary easing measures. First, in the unlikely case that Cyprus decided to sell its reserves, the supply would most likely not have a tremendous effect on spot prices, and any sale would likely be on a secondary market, possibly a central bank to central bank transaction. Secondly, commodities have historically traded rather close to the way equities have traded, thus since equities did not fall tremendously like commodities did, I am led to believe that this is a short-term break in a long-term association between stock prices and commodity prices. Additionally, the movement from non-risk assets to risk assets should continue to take place as long as central banks around the world keep pumping liquidity into the financial markets, which should continue to benefit equities and commodities. Lastly, as to Japan's easing, selling gold appears to me to be a very counter-intuitive move. As the BOJ is moving to increase inflation to around 2% annually, after years of deflation, many would want to move into gold and silver as well as into other risk assets protect wealth over the long-term from the ill effects inflation. I do not find any of the above reasoning able to justify the recent downward move in gold and silver prices.
Many gold and silver holders are traditionally long-term investors who are simply not interested in trading the short-term movements in their prices (Think Central Banks), in addition to using the metals as an inflation hedge to protect wealth over the long-term. The positive outcome of the recent selloff is that many of the "weak-handed" buyers have been taken out the market. This includes day traders and buyers on margin. Thus, the vast majority of remaining "strong handed" gold and silver holders are in the investment for the long-term, which makes me confident that the remaining downside in the market for these two metals is significantly less than the potential upside.
How to Play a Gold and Silver Move
I try to stay away from the gold and silver miners, as they have historically strayed from a close correlation to the price of the metals. Additionally, the miners are exposed to additional risks, such as potential operational problems, or management mishaps. The SPDR Gold Trust (GLD) and the iShares Silver Trust (SLV) are both widely regarded as the easiest and most-efficient ways to gain exposure to these precious metals without physically holding them. I personally prefer using the Central Fund of Canada (CEF) to get exposure to these metals. The fund is comprised of approximately 56% Gold Bullion and 43% Silver Bullion. This gives investors a one-stop shop to invest in these two precious metals. However, any of the above funds will give you exposure to price changes and they all have similar annual expense ratios (Approx. GLD: 40 bps, SLV: 50 bps, CEF: 31 bps).
The recent downward move in metals prices appears to be short-term and provides long-term investors with an attractive entry point for new positions, especially compared to equity markets which are looking vulnerable.
Additional disclosure: I own physical silver bullion.