Big Week for Cryptos… Better Inflation Hedges Than Gold?

Historically Speaking, Silver Is Undervalued vs. Gold, and Gold Is Undervalued vs. Stock Market

Mike Gleason Mike Gleason
Interview with: Mike Gleason
October 22nd, 2021 Comments

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Welcome to this week’s Market Wrap Podcast, I’m Mike Gleason.

Gold and silver markets continue to gather upside momentum as inflation pressures spread throughout the economy.

Gold prices are up 2.4% since last Friday’s close to come in at $1,817 an ounce. Silver, meanwhile, is up an impressive 6.2% this week to trade at $24.85 per ounce.

If silver clears the $25 level in the days ahead, it will make a new 3-month high. That could trigger a new round of technical buying among chart followers.

Turning to the platinum group metals, they are underperforming. The platinum market is up a slight 0.7% for the week to trade at $1,079. And finally, palladium checks in at $2,065 per ounce after suffering a 2.0% a weekly decline.

Metals markets may be starting to reflect broader inflation trends that are manifesting in higher prices for almost everything. These price increases faced by businesses and consumers are showing no signs of letting up, despite the Federal Reserve line that they are “transitory.”

Billionaire hedge fund manager Paul Tudor Jones weighed in on the inflation threat during an appearance on CNBC this week.

Paul Tudor Jones: We have a Federal Reserve Board that are inflation creators, not inflation fighters. It's pretty clear to me that inflation's not transitory. It's here to stay. And it's probably the single biggest threat to certainly financial markets, and again, probably I think to society just in general. So, this 5.4% CPI is a real eye opener. It's the highest CPI we've had in 30 years. And of course, it's going to go higher here in the next few months as energy feeds through it. So, for an investor in particular, most to this audience, it's absolute death for a 60/40 portfolio for a long stock, long bond portfolio. So, the real question is how do you defend yourself against it?

According to Paul Tudor Jones, the best defense against inflation will be not gold but Bitcoin. There’s certainly no arguing that Bitcoin has outperformed gold along with virtually every other asset in the investment universe over the past few years.

The cryptocurrency attained a market capitalization of over $1.2 trillion on its rally Thursday. After having risen tens of thousands of percent to attain that lofty height, Jones risks being late to the party.

It’s difficult to see how anything like Bitcoin’s past performance could be replicated from a current cost basis of over a trillion dollars. But it’s not difficult to see how it could suffer a massive selloff after the latest round of hype fades.

Bitcoin was bolstered this week by the launch of a Bitcoin futures exchange-traded fund. The ETF will hold futures contracts rather than actual bitcoins. That makes it a derivative instrument of derivative instruments that track a highly speculative underlying digital asset. In other words, it’s multiple layers of risk.

The history of commodity futures ETFs is instructive here. They have tended to diverge negatively, sometimes dramatically so, from the underlying indexes they are supposed to track. They have been plagued by price drags from contango and contract rollover – not to mention management fees and other costs.

Bitcoin itself can be owned directly on the blockchain, outside of the banking and brokerage systems and free of their fees and counterparty risks. Those advantages are completely lost by owning futures contracts or Wall Street vehicles that hold them.

Similarly, many of the key advantages of owning precious metals in physical form are lost by holding financial instruments that purport to be backed by metal. Even if they do a good job of tracking spot prices, which is no sure thing, gold and silver ownership is about more than that. People own gold and silver coins for the privacy, the security, and the convenience of possessing money in tangible form.

The debate over whether precious metals or cryptocurrencies are more valuable forms of money will ultimately be settled by the market. Which asset class serves as a better inflation hedge will also be proven out in the years ahead.

Gold and silver have a centuries long track record of retaining purchasing power over time and performing especially well during periods of rapidly rising inflation.

Cryptocurrencies have no such track record. They have been driven more by speculation on their widespread adoption and potential use cases than by inflation fears per se.

It’s true that the number of Bitcoins that will ever be mined is strictly limited. That gives Bitcoin an inherent scarcity in contrast to unbacked fiat currencies such as the U.S. dollar, which can be created in unlimited quantities.

But the number of cryptocurrencies that can be created out of nothing is also unlimited. Who’s to say whether Bitcoin will always be the top crypto? Or whether any of them will be worth anything in a new “beyond digital” internet and computing paradigm that may arrive in the future.

Gold and silver markets will inevitably go through booms and busts in the future. But the metals themselves will never cease to be valuable to various industries, to jewelers and artisans, and to investors who want to hold hard money outside of the financial system.

Meanwhile, gold appears undervalued as compared to the general stock market on a historical basis, and silver is undervalued versus gold.

During the deflationary Great Depression and the inflationary 1970s, the gold price reached a 1:1 ratio versus the Dow Jones Industrial Average.

The Dow trades at over 35,000 today, and that’s about 20 times the gold price.

Were the Dow:gold ratio to revert toward 1:1, either stocks would have to crash, gold would have to launch into a super-spike, or some combination of both.

Given the tremendous inflation pressures currently exerting themselves in the economy, the late 1970s may be the best model for what to expect going forward.

It would mean rising price levels combined with a weak economy (stagflation).

And given that our debt load today is more than four times greater as a share of the economy than it was in the 1970s, investors should brace for the potential of a far greater financial crisis.

In the event that plays out in the form a crash in the value of the U.S. dollar, gold should serve as a premier safe-haven asset.

But silver could perform even better as an inflation hedge. It did during the late 1970s leading up to its January 1980 super-spike high of nearly $50/oz.

Some dismiss that move as artificially induced by the Hunt brothers, who tried to corner the silver market. They shouldn’t dismiss the potential for another mad scramble for scarce supplies of silver, however, fueled by broad and deep global demand rather than a handful of futures market speculators.

This time around it could be Tesla or a solar panel manufacturer, for example, that try to “corner” the silver market by accumulating strategic stockpiles.

Or it could be a large number of individual investors mobilized in internet forums to collectively “corner” the market for physical silver. Crowdsourced campaigns spearheaded by silver enthusiasts are already afoot to try to force the hand of paper futures traders who engage in naked short selling that artificially suppresses spot prices.

For now, silver remains relatively cheap versus not only most financial assets, but also versus other hard assets. In March 2020, silver became historically cheap versus gold – at one point sending the gold:silver price ratio to a record 130:1.

The gold:silver ratio currently checks in at about 76:1. It still has a lot more room to narrow in favor of silver during a precious metals bull market.

At the 1980 peak, the ratio came close to hitting 16:1, which is often referred to as the “classic ratio” observed going back to ancient times.

Meanwhile, the current mining ratio is only about 7:1, according to First Majestic Silver CEO Keith Neumeyer. That is to say, mines worldwide are producing 7 ounces of silver for every one ounce of gold they bring to market.

With so many ratios seemingly out of whack, investors would be wise to reconsider the ratio of hard assets to paper assets in their portfolios. And those who already have a prudent allocation to gold bullion should be sure they also have an adequate ratio of silver holdings.

Well, that will do it for this week. Be sure to check back next Friday for our next Weekly Market Wrap Podcast. Until then this has been Mike Gleason with Money Metals Exchange, thanks for listening and have a weekend everybody.

Mike Gleason

About the Author:

Mike Gleason is a Director with Money Metals Exchange, a precious metals dealer recently named "Best in the USA" by an independent global ratings group. Gleason is a hard money advocate and a strong proponent of personal liberty, limited government and the Austrian School of Economics. A graduate of the University of Florida, Gleason has extensive experience in management, sales and logistics as well as precious metals investing. He also puts his longtime broadcasting background to good use, hosting a weekly precious metals podcast since 2011, a program listened to by tens of thousands each week.