The ‘Gold Cliff’ And Silver’s Half Price Sale
Tuesday, July 17, 2012
Precious metals continue to be pushed onto market participants, for they are the rocks to hold when the world will start spinning out of control -- and to each his own. In December of last year I wrote the article "Gold's Trump Event And India's Weak Demand," and it started like this.
As gold reached for the sky, with the interim daily high of $1,920 taking place on September 6, the word spread that the metal was the "thing" to own, and the argument for further gains was plastered all over the media. Then on September 15, Donald Trump accepted a security deposit in gold for a lease by American Precious Metals Exchange.
On that day, gold December futures opened at $1,821 and closed at $1,779, or a drop of $42, which was a small decline considering the price - but it appears to have been a "Trump Event," similar to a "Shoeshine Boy" moment.
Since that time, gold dropped to $1,550 and then rose to $1,800, give or take a few bucks. The price last Friday for the August futures contract was $1,592, or 10.5% below the closing price on "Trump Event" day. In addition, the "India factor," a favorite indicator of many gold bugs, was already showing signs of demand weakness, which was highlighted back then through the Reuters' article "Surging gold prices push Indians to rein in, recycle." More recently, Reuters reported that "India gold demand tad up on price fall," but the details are far less encouraging.
India's gold imports could pick up in the second half of 2012 if record prices ease but annual volumes will still fall about 30 percent after a tax increase, which could crimp demand until 2014, the head of Mumbai's gold trade association said in June.
A picture is always worth a thousand words, and the gold chart on a monthly basis provides a good long-term perspective and defines the lines on the sand.
What has become apparent as of late is that the $1,550 price has provided enough demand to prevent the metal from falling towards the red line, or about $1315, and the gap is the "Gold Cliff." From the record price of $1,920 attained on September 6, 2011, gold has lost only 17%.
On an interim basis, silver peaked at $49.82 on April 25, 2011, and had lost 45% of its value as of Friday's closing. If the price falls below the $25 level, the $15-$20 range looks very solid. Depending on one's core beliefs, silver is either on sale for half-price, or ready to have a cliff of its own. Despite the various arguments that pits some gold holders against silver investors as to which metal is the best hedge against whatever it is that they are hedging against -- and there's no clear consensus -- the fact remains that both metals have "underperformed" over the last 12 months.
But aside from the still rampant Armageddon theories, what are the catalysts going forward? The first is, without a doubt, instability, be it from Europe or the Middle East, with the latter being the most difficult to gauge. But while the European crisis continues to unfold, getting worse by the day, gold has not responded. The Iranian issue doesn't seem to be compelling enough, either.
The second, and more important, relates to currencies, especially as they trade against the dollar, and what Jean-Claude Trichet, the former ECB chief, had been avoiding throughout his reign, has now been reversed by Mario Draghi.
The biggest fear that Trichet had, in my opinion, was that lowering interest rates would lead to capital fleeing Europe, and the train has now effectively left the station. Certainly there are alternatives, such as the Australian and Canadian dollars, but those markets aren't large enough to absorb the flows, not to mention the impact that the visible global economic slowdown will have on these raw material dependent economies. In addition, the also small Swiss economy doesn't want the capital either, and will print francs until the cows come home to ensure that the franc will not hinder their exports. Chinese yuan? Forget it!
The flow into other currencies was well captured by the Canadian Securities data as published by Statistics Canada, with foreigners picking up a record C$26.1 billion in bonds and equities.
Non-resident investors purchased $16.7 billion of Canadian bonds in May, the largest such inflow of funds in three years. This activity was led by a $9.5 billion foreign acquisition of federal government bonds mainly on the secondary market, largely composed of instruments at both ends of the maturity spectrum.
In addition the recent U.S. Treasury International Capital report showed that "foreign residents increased their holdings of long-term U.S. securities in May - net purchases were $50.1 billion. Net purchases by private foreign investors were $19.9 billion, and net purchases by foreign official institutions were $30.2 billion. At the same time, U.S. residents decreased their holdings of long-term foreign securities, with net sales of $4.9 billion."
Thus the risk going forward, and what will stimulate the "Gold Cliff," is a rise in the U.S. dollar, even with the country facing another credit downgrade. In addition, the long-term dollar decline trend that started in 2003 has, far more likely than not, come to an end, and the expectation that the greenback will flounder will fade further over time. If the dollar reaches 2003 values, we're talking a 25% rise from here.
On the opposing side we have QE3, and any other stimuli the Fed is willing to throw at the market, but the jury is still out on any action. From an economic standpoint, it will be another exercise in futility, although that never stopped the Fed from moving forward with its policies.
Lastly and as an important side note, patience is wearing thin for the investor segment that was sold on precious metals as a diversification strategy and/or a hedge against a hail storm of paper money and inflation, because those well advertised theories are having a difficult time holding any water.