Silver excess

Silver: That silver and gold are racing to new records is a bad sign. There is physical demand for the metals but, as Barclays Capital says neatly of silver, “prices have discarded their fundamentals”. The silver price, in the region of $15 per ounce in September last year, is now over $39 per ounce. Its staggering 160 per cent advance in little more than six months is a sure indication of speculative excess.

Investors have rushed to buy silver s a safe-haven investment in the mould of gold because it was seen, until recently at least, as a cheaper way in. In part, the precious metal bubble has been pumped by geopolitical fears while the ongoing euro zone debt crisis has also had its part to play. But one thing, above all others, is supercharging the price of silver: the Fed’s decision early in November to print $600 billion in a second round of quantitative easing. The silver-gilt investment thinking seems plain. If dollars are being printed like so much green wallpaper, money you can bite — such as silver and gold — seems so much better.

Fed policy is blowing the bubbles. The latest surge in precious metal prices coincides with Fed minutes showing some officials thought “exceptional policy accommodation could be appropriate beyond 2011.” The Fed sees its money printing as insurance against renewed economic weakness but its policy could easily rebound badly on a recovering US economy in which there is now a palpable inflation risk.

If inflation rises, US monetary policy could change abruptly. That would prick bubbles around the world. Gold and silver could fall precipitously.

Higher interest rates would cast the income deficiencies of precious metals into sharp relief. True, silver has industrial uses — especially in electronics — and its price may receive some support from world economic growth. But silver’s history is a warning. It also behaves as a sort of “geared” gold play, outperforming the yellow metal in times of excitement but deflates faster when the bears get the upper hand.

The five-year average price of silver is $16. It does not need to go all the way back there, from its current $40, for investors to lose a fat pile. Those who have fled printed paper may find their precious assets are anything but solid.