How does one invest in the midst of a recession? What should you do with your money to both keep it safe and see it grow during times when you need it most?
Every investor wants to do that. But, looking to the patterns of history, it seems there is one type of trade that tends to perform very well -- if you're keen enough to spot it, courageous enough to execute it, prepared enough to afford it and humble enough to sell it when the situation demands.
Precious Metals Are a Timeless Safe Haven
Precious metals, specifically gold and silver, are some of the most ancient forms of almost universally accepted money. For whatever reason, homo sapiens seem to ascribe some metaphysical worth to these two shiny elements.
It's important for investors to accept this simple axiom, because it leads quite nicely to the conclusion that gold and silver, these long-accepted notions of money, aren't bad options if you're looking for a place to park your assets during a recession.
Despite this being widely known on Wall Street, it hasn't stopped some from making enormous fortunes by buying gold or silver in bleak economic times.
Hedge funder John Paulson, who skyrocketed to fame in 2007 after his purchases of credit default swaps netted his firm a fortune and his personal account $4 billion, made billions more just a few years later.
Still capitalizing on gloom and doom, Paulson made another $5 billion in 2010, returns that were boosted by his bets on gold, which had nearly doubled from its 2008 low of $865 an ounce by the end of 2010. He did so through means available to everyday retail investors, most notably the SPDR Gold Shares (ticker: GLD) ETF.
Use the Gold-Silver Ratio to Spot Opportunity
Value investors like Warren Buffett are typically frustrated by investments like gold, because it doesn't fit with their tried-and-true framework, which requires analyzing a company's fundamentals and determining what a fair price to pay for such a company would be.
Buffett calls this "intrinsic value" and has made tens of billions of dollars by understanding it better than anyone else on Earth. Gold doesn't have fundamentals. Buffett can't know what its intrinsic value is, so he doesn't touch the stuff.
Thankfully, there is one metric with a great track record of telling investors when one of the two main precious metals may be overvalued or undervalued.
It's the gold-silver (G/S) ratio, which is simply the price of gold per ounce divided by the price for an ounce of silver.
By looking at gold prices in relation to silver prices over the last 100-plus years, a ratio of about 50-1 is widely considered a "normal" level.
Admittedly, this ratio fluctuates wildly over the short term, and it can gyrate for different reasons. But it's the central factor in determining what you should invest in during a recession, so pay close attention to it.
Buy Silver if the Gold-Silver Ratio in a Recession Is High
No investment strategy that can earn huge returns works 100% of the time, every time, but to get a sense of what a powerful signal the G/S ratio can be, let's look at all the times since 1971 (when the U.S. left the gold standard, in which dollars were backed by gold) where the G/S ratio exceeded 80.
Four of the five times the G/S ratio has exceeded 80, there were opportunities to buy silver at attractive prices.
The first was in 1990, and lasted for over three years. Since this was the first time markets saw a ratio above 80 since the gold standard ended, it's reasonable to assume there was some price discovery going on -- something markets would greatly improve on in the decades to come.
In 2003, investors who bought silver after this ratio hit 80 were rewarded with 390% returns in five years.
In November 2008, conditions were supercharged, and presented the perfect situation for the opportunistic investor. Not only had the G/S ratio hit 80, it was during one of the most brutal recessions ever, and unlike 1990, markets felt more firmly convinced this ratio would revert to the mean.
Buying silver in November 2008, the month the gold-to-silver ratio hit 80, would net the patient investor 350% gains had they waited for the ratio to get wacky in the other direction, which it did in April 2011 when gold traded for just 31 times what silver was fetching.
If you'd bought the fourth time this ratio exceeded 80, you'd have bought silver in March 2016. The tactic of looking for a short-term exit strategy would've suited you well here: if you waited just four months for the ratio to hit 66, you would've ridden silver from $16.65 an ounce to $21.69 an ounce for 30% gains.
As for the fifth time the G/S ratio hit 80, it's an ongoing situation. Markets have offered that ratio more or less uninterrupted since early 2018. It's quite likely there are short-term gains to be made here, but the most compelling opportunity would only come if the U.S. went into a recession and the ratio remained elevated.
Investors of all income brackets can gain exposure to the overlooked metal through silver ETFs, the largest of which is iShares Silver Trust ( SLV). The next best option is Aberdeen Standard Physical Silver Shares ETF ( SIVR), whose expense ratio of 0.3% is less than the 0.5% SLV charges.
Since silver prices often fall more quickly than gold prices do, and recessions typically do cause short-term declines in precious metals prices as they first come on, each of the last three recessions has seen the G/S ratio increase at their onset.
Using Silver's Achilles' Heel to Your Benefit
Recessions are bad news. Ten years after the last one, millions of Americans still live below the poverty level, wealth inequality is out of control, and rent, housing costs, medical bills and student loans are making life in general practically unaffordable.
On the brighter side, if there is a recession soon, it's likely today's already elevated gold-silver ratio will keep rising -- a measure of 90 or 100 isn't out of the picture.
It's here, at this point of historically great misalignment, that investors should consider buying silver and determining how long they're willing to wait for what sort of returns.
Once the country emerges from the next recession, it's highly likely the G/S ratio will revert toward the mean, most likely as silver prices rise far more rapidly than gold prices do. Silver's Achilles' heel -- its volatility -- has historically been its greatest asset for the opportunistic investor. While silver prices may fall more quickly than gold prices, it also almost always bounces back more quickly as well.
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