-- Posted 10 February, 2011 | | Discuss This Article - Comments:

Less than 45 days into 2011, it appears that this just may be the year of the paper recovery, but that doesn’t mean that lingering problems have been wiped away.  At center stage now is the municipal bond market, which having grown tremendously as investors fled to safe havens in 2009, may soon find itself in a perilous situation.

The problem now is that the markets are struggling to find enough capital.  Throughout the financial crisis, municipal bonds perceived to be less risky than other investments accepted cash in droves.   This new investment was buoyed mostly by a large, Federal stimulus package that stood as an underwriter for new debt issuance.  That is, states could issue more debt to take advantage of ultra-low financing costs before passing on the one-year expenditures to the Federal government.

Thus, first-year borrowing costs were nil, and so too were the long-term borrowing costs expected to be.  However, as the markets recover with tons of paper cash, investors aren’t all that interested in low returns, nor do they believe municipal bonds to be worth the inherent risk they bring forth.  While few municipalities have ever gone bankrupt, many are reaching breaking point this year, as the costs of running these cities grows exponentially while revenues continue their decline on poor housing values.

Municipal Bonds and Metals

Municipal bonds are considered to be what gold and silver have always been: a reasonable store of value and protector of wealth.  The idea is that municipal bonds are generally very regular on their interest payments, incredibly safe, and also tax-advantageous.  As a result, they became an investment staple of the insurance business and are still, to this day, one of the single most important assets to that industry.

However, with the markets in turmoil, and few knowing the extent to which they are exposed to municipal defaults, any future shocks will play out well for gold and silver holders.  All things considered, gold and silver can provide near equal returns for investors from arbitraging and option contract sales. 

Plus, when contracts are written against gold and silver owned by a company, the earnings are taxed as ordinary capital gains, not as collectables.  Thus, gold and silver present an opportunity for profits on rising inflation, as well as routine cash-flow for insurance companies, a necessity of any investment.

Small Muni Shift = Major Movement for Metals

Whether or not the business will shift entirely to gold, silver, or other commodities is of little concern, mostly because it requires only a small shift in assets for commodities to move quickly.  The municipal bond market rests at a value of just under $3 trillion, a size that dwarfs the commodity markets and any above ground supplies for both gold and silver.   If even a fraction of this cash were to migrate to an investment with similar risk profile and roughly the same risk-adjusted returns, then silver prices would have more upward trajectory than ever before.  In 2010, less than $100 billion in funds were added to gold ETFs.  That amount is just over 3% of the current supply of muni bonds.

Do the math.  Silver and gold make sense.

Dr. Jeffrey Lewis

www.silver-coin-investor.com