What happens when silver hits $50 an ounce?

It’s looking like the question shouldn’t be whether or not silver will hit $50 an ounce, but rather what will happen when it does?

It’s increasingly looking like silver will take out it’s all-time high of $49.45 set in January 1980. The metal rose 80 percent in 2010, and it’s tacked on another 41 percent since the start of the year. Prices now hover around $44 an ounce – just $6 away from record levels. It’s looking like the question shouldn’t be whether or not silver will hit $50 an ounce, but rather what will happen when it does?

Having come of age long after the 1970s, I’m fortunate not to have lived through an oppressive period of inflation. I’m unfortunate, in a sense, though, because if I had, I probably would have taken out long positions in gold and silver years ago.

What I didn’t understand then is the same thing a lot of people don’t understand now: precious metals act as a store of value. If the dollar’s dropping in value, it will take an ever-larger number of dollars in the future to buy the exact same amount of silver. By holding silver instead of greenbacks, you are, in effect, protecting yourself from the erosion of the dollar’s purchasing power.

Throw in some speculators, growing budget deficits and a dash of geopolitical stability and silver’s powers as a store of value get compounded by increasing demand for the metal. That’s how we’ve gotten where we are today, and tomorrow doesn’t look much better.

In fact, I expect silver to break through the $50 mark and – after a consolidation period – keep climbing; perhaps into the triple digits. Here’s why:

1) Inflation has reared its ugly head. According to the U.S. Bureau of Labor Statistics, the Consumer Price Index has climbed a mere 2.7 percent over the past 12 months. Shadowstats.com puts that number at more than 10 percent. The red line below represents the government’s “official” CPI numbers. The blue line indicates the CPI as calculated by Shadowstats:

Of course, you probably don’t need me to tell you inflation has arrived. I suspect you’ve noticed you’re paying more at the pump and the grocery store than you have since 2008. That’s an indication of just how troublesome it is to be holding cash right now.

2) There’s more inflation on the way. We may not get a QE3, but the Fed will need to come up another way to continue growing the money supply by the end of the year. The national debt has simply gotten too large for the government to control without printing money. Consider the fact that the U.S. GDP stands just north of $14 trillion. That’s the total market value of the entire U.S. economy. The national debt is also north of $14 trillion giving us a debt-to-GDP ratio near 100 percent. Interest payments on that debt are expected to amount to $242 billion in FY2012. That doesn’t sound like much when we’re used to talking in trillions, but consider Congress’ recent fight over trimming $38.5 billion from the budget. That battle nearly shut down the Federal government. Until Washington gets serious about reforming spending, the debt will dictate the Fed’s monetary policy (i.e. the printing presses will continue to roll).

3) The echo chamber. As investors flee inflation by moving into precious metals, pressure on the dollar mounts. “The U.S. credit rating will undoubtedly be lowered in the next few years,” Michael Pento, an economist at Euro Pacific Capital in New York, told Bloomberg yesterday. “This will mean much higher borrowing costs and a much lower currency. International investors have been using gold and silver as an alternative currency and an alternative to the dollar, and this will only exacerbate and accelerate that process.”

4) $50 today isn’t $50 in 1980. For silver to truly break its record high in 1980, it will need to do so in inflation-adjusted dollars: an amount that’s closer to $150 an ounce. The eerie similarities between today’s economy and the economic climate in the 1970s make me think we have a long way to go in silver prices. Once we break through silver’s psychological barrier at $50 an ounce, there may be a powerful sell-off, but I’d view it as a buying opportunity. So long as our government fails to restore faith in the dollar, commodities will remain king.

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