With the US Federal Reserve backed into a corner by a mountain of toxic assets and soaring US deficit spending, the easy way out is to invite, foster and perhaps even beg for inflation. With the world currency markets, foreign central bankers and even US politicians seemingly willing to invite, foster and perhaps even beg for a significantly lower US Dollar, there would seem to be yet another historical inflationary building block in place.

Never in the history of modern trading have there been so many ways to invest in commodities, and record amounts of capital are already flowing aggressively toward them. We would suggest that the sub-prime crisis has also caused investors to diversify and that the allure of more traditional financial instruments and the attraction to real estate might remain damaged for years. That in turn seems to be increasing the flow of capital toward the metals and a host of physical commodity markets. In short, we see the interest in tangible hard assets continuing to soar, especially with inflation prospects and the action in the Dollar putting commodities on a very high pedestal.

With the US Federal Reserve taking great pains to communicate their intention to “leave historically low interest rates in place for a long period of time,” it will be a very interesting trick for the Fed to time the removal of the punch bowl at the exact time that the “party” manages to become self propagating. While some players might believe that the precious metals rally is already well into its move and that a top is nearing, we would suggest that several more months of rising unemployment and ongoing concerns for the commercial real estate threat should be enough for the Fed hold onto their guns and keep money loose even in the face of classic inflationary signals. Remember the Fed and the US Government need to see signs of sustainable growth. It’s possible that real signs of inflation will be flashing warning signals well in advance of an improvement the jobs sector.

Since the Obama stimulus package was supposedly a long-term jobs creating tool and health care reform has been touted to be capable of producing 10 million jobs, one could suggest that little near term growth should be expected but that long term growth will be fantastic. However, given the amount and duration of global quantitative easing in place and the stubbornness of the UK and US job situation, one could also suggest that the US and UK will have to accept the greatest inflation risk of all.

We should point out that gold has already exceeded the March 2008 highs by 5.6%, while silver has yet to do so. December silver recently made it to $18.175 per ounce versus the March 2008 highs for nearby futures at $21.185. Recent silver prices are also well short of the all time high for cash silver, which was achieved in January of 1980 at $48.00 per ounce!

With the gold market recently seeing record spec and fund long position readings in the weekly Commitment of Traders reports while forging a series of new all time highs, it is clear that gold has been the primary target of the initial wave of inflationary anticipation.

In contrast, the combined speculative net long position for gold reached a record 328,344 contracts recently, exceeding the record set on September 22nd, 2009 by 20,401 contracts. This leaves gold in an overbought condition.

If the US dollar continues to push lower, more and more investors will be interested in holding hard assets instead of paper ones. This may be yet another reason to expect increased buy-and hold investor interest in silver.

World demand for silver has exceeded the supply (mine production plus scrap) for most of the past two decades, as jewelry and industrial demand for silver has remained strong. As the world emerges from the recession, we would expect the silver to continue to show a production deficit, as mining is expensive and the 2008 collapse in prices for metals brought on by recessionary demand keep the production recovery even slower than the demand recovery.

While gold has been the popular choice of investors as a hedge against inflation and against holding the US dollar or other paper currencies, the record high price may cause a shift to other assets such as silver, palladium, crude oil and even agricultural markets. Of these, silver is likely to be the most popular, as a crumbling dollar and uncertainties in other commodity markets’ supply and demand forces (weather, OPEC, political issues, etc.) may cause investors to lean towards a “keep it simple” approach.

Suggested Trading Strategy:

* Buy 2 December 2010 silver $25.00 silver calls and sell 2 December 2010 silver $30.00 silver calls for a net cost of 40 cents or better for each spread. Risk the trade to a combined loss of $2,500 or 62.5% of the initial premium outlay. Use an objective on one of the bull call spreads at $1.00 or a gain of 60 cents, and look to hold the remaining bull call spread for an initial target of $24.00 basis the December 2010 silver futures.

If you’d like to further discuss these strategies to determine the best execution strategy for you, contact Daniels Trading.

Daniels Trading

About Daniels Trading

Daniels Trading is a relationship-focused commodity futures brokerage located in the heart of Chicago’s financial district. Founded in 1995, they have a history of providing effective and reliable trade executions to both individual traders and institutional investors around the globe. In addition to a focus on relationship and execution, Daniels Trading is a leader in providing ongoing education opportunities and resources for customers.