1 Answer

The price of gold has surged recently, surpassing an important barrier of $1,500 per ounce. Gold has been up every year since 2001 and has increased roughly 25% in the previous year.

Gold was outshined by another precious metal, however. Silver has reached a 31-year high by almost beating the $44 mark. In the last year alone, it has raced ahead by almost 150%. No wonder some investors are now referring to silver as gold on steroids. A word of caution: the price of silver does tend to be more volatile than its gold counterpart.

The question is: can the precious metals keep up this pace?

(To see how Eastern European currencies are gaining on the USD, go here).

The answer depends on why their prices are surging in the first place. Investors are divided on this issue. Some argue that the soaring prices of precious metals are driven by market speculators. It is just another bubble waiting to burst, much like the housing bubble in the US in 2007. When will the bubble burst? That is difficult to tell. But the main point is that it will burst sooner or later.

Other investors believe the rise in gold and silver is not the result of crazy speculation; rather, they feel that the rise is connected with the economic fundamentals of modern economies. One important thing to remember is that the prices of gold and silver are not related to industrial demand. The price of copper, for instance, has gone down over fears that the economic recovery might stall.

Gold and silver, on the other hand, flourish on news of problems in the economy. Precious metals have been driven up by fears of crumbling economic activity and creeping inflation. The price of both gold and silver skyrocketed after S&P changed the outlook of US debt from stable to negative. Lowering the US credit rating will make borrowing for the US government much more difficult and expensive, leading to a weaker dollar.

The precious metals have also been propelled by problems in another major paper currency – the Euro. Eurozone’s two-speed economy – with the recovery gaining firm ground in countries like Germany and France, while debt-ridden economies of Eurozone’s periphery remain very close to declaring bankruptcy – raises fears over long-term sustainability of the Euro project. Such prospects are likely scaring some investors away from the Euro.

When things get rough, investors want to invest in something more tangible than stocks or paper currencies, which are ultimately just pieces of paper.

Precious metals should be viewed as just another form of currency. The major difference between the dollar and gold/silver is that the latter relies on mining. In general, the increase in the supply of precious metals is a single-digit number on a yearly basis. On the other hand, the supply of dollars is controlled by the Fed, which has the power to increase its supply by a much larger amount.

This is exactly what the Fed has been doing with the program of quantitative easing, prompting many analysts to comment on the liquidity flood of biblical proportions. A strong rise in the supply of major paper currencies also contributed to their fall in value in comparison to gold and silver.

How far gold and silver can go ultimately depends on whether you believe their rise is driven by speculation or economic fundamentals. If speculation is your pick, beware of a sudden burst in the bubble. On the other hand, if you believe the surge is due to unfavorable fundamentals of the world economies, you might expect this rise to continue for some time.

From Forbes.