Considering most analysts anticipated that Federal Reserve Chairman Ben Bernanke would announce Wednesday he was finally easing off the throttle of his bond-buying program, the markets were overcome with shock and awe as he declared he had no plans whatsoever to halt his massive and infinite quantitative easing effort.
The stock market ripped to new record highs after the announcement on the understanding that the drunken excess was going to continue. Yet gold and silver also surged as buyers realized the accompanying hangover that will most assuredly come will be even more painful than before.
As savvy investor Marc Faber said, the Fed's position has become completely untenable and "the endgame is a total collapse, but from a higher diving board."
What the announcement also suggests is that the economy is far weaker than we were led to believe. The Fed cut by as much as 17% its estimates for GDP growth next year, from 3%-3.5% in June to 2.9%-3.1% on Wednesday, no doubt driven in large part by its estimates for personal consumption expenditures inflation tumbling by 10% at the high end to 1.8%. That's significant because the Fed has said it will not raise short-term interest rates -- keeping them near 0% -- so long as PCE inflation is below 2.5% and unemployment rates remain above 6.5%. It expects unemployment to remain between 6.4% and 6.8% next year, though we all know the nonparticipation rate, the true measure of those without jobs, is at all-time record highs.
That bodes well for gold and silver to recover their role as hedges, and is why I've maintained all along there is a coming boom again in their prices. The miners themselves benefited from the news, most gaining double-digit percentage increases, though perhaps the greatest risk for them lies not in an economy that truly improves, but whether they've hedged production and to what extent.
Earlier this year Great Panther Silver, which jumped 11.5% yesterday, reported it had no hedges on its silver , while Pan American Silver (NASDAQ:PAAS) presciently just announced it was closing out all of its hedged silver and gold positions, which represented 20% and 18%, respectively, of its forecast production. At prices of roughly $20 per ounce for silver and $1,323 per ounce for gold, it could have sustained a serious impact if the precious metals take off as expected. Its stock was up 9% yesterday. Silver Wheaton (NYSE:SLW) is 100% unhedged and was up a like amount to Pan American.
On the other end, Hecla Mining (NYSE:HL) said last month it has begun hedging all of its metals once they're shipped as a means of protection from price volatility. The company said it had sold about 40% of its 2.2 million ounces of silver production in June, a month that featured a lower average silver price than that of the second quarter. It bemoaned the fact that silver prices fell 40% to $16.27 per ounce while spot prices dropped 21% to an average of $23.17 per ounce.
The positive note to take away from this is that Hecla's cash costs net of byproduct credits were still $5.56, down 21% from the first quarter.
Gold miners face the same conundrum. Ashanti Gold caused the precious metals miners to acknowledge the risks of hedging, as it took on contracts at precisely the wrong moment as gold spiked more than a decade ago. Subsequently sold to AngloGold (NYSE:AU) on the cheap because it was in such a weakened financial state, Ashanti became a cautionary tale for hedging -- and of doing business with Goldman Sachs, which played all sides in the miner's downfall.
Interestingly, it wasn't that long ago -- days, really -- that Goldman was once again advising gold miners to hedge their production, forecasting prices would fall as low as $1,050 per ounce. In the wake of Bernanke's full throttle speech, however, the investment banker reversed course and now sees more upside to the yellow metal. Yet just last month it was recommending investors sell their gold, even though it was a buyer itself.
The miners seemingly have avoided falling into the trap again of listening to the investment banker, and investors should take heart that they're better positioned to reap the windfall of the coming boom. Yet if Marc Faber is right, investors would do even better by being in physical possession of gold and silver than in stocks or ETFs trading in them.