-- Posted Friday, 7 May 2010 | | Source: GoldSeek.com
By: Dr. Jeffrey Lewis
Historically, the “fear index,” or the VIX, had minimal impact on the price of precious metals. However, as investors forgo treasury bonds in search of even safer investments, the VIX is correlating very well with the price of precious metals.
The Risk Spiral
With each passing recession, the appetite for risk among investors grows smaller and smaller. Previously, investors would shed equities for corporate debt, knowing full well the economy would recover and most businesses would survive and make good on their obligations.
Decades later, the growth of international banking organizations brought about new fears. With economies so interconnected, many investors feared corporate debt was not safe enough, and instead of buying bonds with liquidated stock proceeds, they fled to government debt. Thanks to an open printing press and eager-to-inflate chairmen, the printing presses ensure the debts will be repaid, albeit with less valuable currency.
Fast forward another decade, and treasury bonds are no longer safe enough. Instead, investors want hard assets. They don't want debt – they want silver and gold!
Eying the VIX
The VIX reading is calculated with the help of historical options premiums on S&P 500 stocks. When option premiums grow larger, the market is expecting more volatility and more risk, since option traders are building in larger gray areas into their option contracts. When the premium grows smaller, the market is expecting less risk and less volatility, pricing in less room for quick changes in price ahead of option expiration.
In recent months, and ever since the financial crisis of 2008, precious metals have had a generally strong correlation with the trend in the VIX. When the VIX is up, precious metals soar. When it falls, precious metals prices contract. This is true all but in the first month following the credit crunch when fears of rampant deflation sent metals to shed 30-40% of their value.
Getting Lucky with Monetary Policy
With each new recession, the power of the central bank and Congress are diluted, evidenced by growing stimulus packages and interest rates plunging to their lowest levels ever. The US economy may have avoided or delayed the eventual burst of the largest asset bubble ever created, but don't be fooled; next time, Congress and the Fed will have to work even harder.
Unfortunately, the problem is now that they won't be able to make much of a difference. Congress has maxed out its credit card, and for the Fed to take interest rates even lower, it would have to PAY people to use money. The Bank of Japan tried this negative interest rate policy and has yet to recover from what was said to be a 10-year recession, even though most would argue the same recession is still continuing.
Buy on Volatility
Investors’ appetite for risk has dwindled so far that only hard assets are suitable for most investors' portfolios, proving the natural strength that commodities have in both bull and bear markets. In the short term, until the next recession, the VIX indicator should continue on its correlation with metals. When the VIX rises, buy with both hands, and when it falls, consider cutting back on your long term purchases. Of course, with inflation assured, and the next recession sure to be ten times worse than the previous, there is plenty of room for error.
Dr. Jeffrey Lewis
www.silver-coin-investor.com
-- Posted Friday, 7 May 2010 | Digg This Article
| Source: GoldSeek.com
