Uncertainty
about the timing of Federal Reserve tightening, a declining dollar, rising
interest rates in the U.S. and turmoil in Egypt propelled gold more than 7% in
8 trading sessions to a 4 month high. Silver fared much better with an
incredible 22% rise over the same time period. This market action has been
catastrophic for the short sellers.
Among other things, the rise demonstrates capitulation; it’s too
dangerous to short the market. My contention is still for higher gold and
silver prices, although my near term outlook is just a bit cautious. Markets
that go straight up are dangerous. The outcome is never constructive. “Profit
taking” would be helpful from those who get out with the thought of buying back
in with metals at lower prices. The gold and silver markets need a pause. I
don’t think there will be a steep decline but a pull-back of 3 or 4 per cent
would actually be beneficial. However, there are still so many naysayers and
doubters (contrary indicators) that the markets could still move higher before
volatility comes back temporarily; especially during the summer doldrums when traders
and bankers are on extended holiday.
An
argument in favor of near term higher prices comes from a change in sentiment
at JP Morgan. The bank’s precious metals team now sees a number of reasons to
be long gold and silver. They note unprecedented physical demand combined with
seasonal positives. The question I have is, given that none of these are “new”
facts, why the change of heart now, especially as JPM is also buying? They
point to Paulson & Company’s liquidation of half of their gold exposure in Exchange
Traded Products (ETPs.) As per JPM’s
press release, “This may be delivering an exclamation mark to define the end of
the 10-month, 25% fall in gold and 50% fall in gold equities…” They also
mention the World Gold Council’s report that physical gold demand remains
strong, questioning the weakness in the paper (ETPs and gold equity markets) a
fact we already knew for months.
To
witness physical demand, just look at the COMEX futures contracts for gold and
silver. The spot month prices are actually higher that the future months, a
characteristic known as “backwardation.” Future months are usually higher
reflecting storage costs. When the spot month is higher than the future months,
the term backwardation is used to demonstrate strong physical off take;
investors and traders are settling their contracts in physical gold and silver
rather than liquidating contracts for cash settlement. The physical metal comes
out of COMEX designated warehouses such as JPM which shows a very small
inventory of only 100,000 ounces. If the exchange can’t deliver gold or silver
to traders, a “force majeure” may be declared in an emergency when no gold or
silver is available for delivery. There is a small chance that scenario might
occur sending metals prices skyrocketing. Nevertheless, there is strong
worldwide enthusiasm for gold and silver with China set to overtake India as
the top gold consumer this year. The evidence keeps piling up that liquidation
from ETPs and gold funds found their way to central banks and private investors.
Earlier
I mention rising interest rates in the U.S are an important driver of gold and
silver prices. The steep and rapid back up in long term interest rates has
rarely been seen. Long term interest rates have broken out of a 30 year
historic down trend. Elsewhere, there have been “unusual” price movements such
as the temporary 5% move in Chinese equity prices last week. These clues lead
me to believe that economies around the world are slowing and that rising
interest rates will put a further damper on economic growth and consumer
spending. Rising interest rates in the U.S. will also put a damper on the
housing market, a main driver of growth recently. Home mortgages will become
more expense and fewer people will qualify for loans. In addition, financing
for automobiles and other capital expenditures will become more expensive. Further,
with slowing construction, manufacturing and services sectors the tax revenue
base will decline straining social services and unfunded liabilities like
Social Security and pension funds.
Since
gold and silver prices are outperforming equities and bonds in this rising
interest environment, it could signal a worst case scenario for the global
economy. Inflation hasn’t show up in economic numbers yet although the goods
and services people pay for everyday are rising; such staples as food, petrol,
medical costs, and education continue to increase month after month.
The
fall could be the decisive turning point for the global economy as investors
flee equity and bond markets and awaken to the prospect of crimped growth due
to unforeseen spiking interest rates. Gold and silver will continue as a hedge
against global economic turmoil, and rising inflation.
Source: JPM Rress Release
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