Precious Metals Headed Higher: Here's How I Know
Chris Marchese
Precious metals have been showing signs of an impending breakout to the upside. I'm not one for technical analysis or price action in equities or anything else for that matter, but the current rebound in the precious metals, notably gold, has caught my eye. While gold held its own around $1,100/oz, reaching a low around $1,080, it is currently trading above $1,125/oz.
My bullish sentiment on gold in the near and medium term and especially longer term is due to the following:
Investment demand has picked up substantially, a trend I expect to continue for years to come.
Gold has been rising despite a rather strong rally in the USD, currently standing around 80.53. This is very indicative of the increasing attractiveness of gold by central banks, institutions and retail investors. When gold peaked before the financial crisis, the USDX bottomed around 72, which caused gold to reach $1020/oz. Assuming investment demand does not continue to gain momentum, just returning to the 2008 low of the USD, gold would be 11.85% higher.
The IMF is notorious for selling gold at the bottom of a bull market, a trend that remains intact.
The announcement by the IMF to resume their approved 400 metric tons of gold onto the open market didn't impact the price of gold, but actually may have spurred investment demand as it has risen approximately $35/oz over the last 10 or so trading days. The sale of gold to India last year saw gold have a $75/oz move from the day's low-high.
The Fed hiking the discount rate 25 basis points to .75% was meant to give the illusion that tighter monetary policy is on its way failed to convince the market. (Discussed in depth in my most recent newsletter.)
The smart money, namely George Soros, first claimed gold was the “ultimate asset bubble,” only to see him drastically increase his exposure to the yellow metal soon thereafter.
A tsunami of Treasury auctions are set to take place this year, amounting to a total 2.1 trillion (give or take) to fund this year's budget deficit. The Fed is likely to monetize a sizable portion of this debt due to the difficulty the Treasury will face off-loading such a large quantity onto the market. Perhaps this would have been an easy feat in the 90s or the first half of the last decade, but with the debt ceiling now in excess of 14 trillion, the market will soon realize that buying US government debt is not “risk free” with a default likely. It may not be an outright default but via inflation (which is essentially the same thing).
Foreigners, especially the main buyers in our Treasury auctions, have become increasingly concerned about our ability to pay this back. Last year China and Brazil agreed to trade in RMB or real (though the magnitude and frequency have yet to be seen). China is also aware of their frothy economy, aware it is very prone to asset bubbles forming. This has caused them to tighten monetary policy, increasing their reserve requirement in order to curtail lending.
China and Japan have both been selling U.S debt (though not a sizeable portion), but this is another trend likely to continue. Japan is now the largest holder of US Treasuries despite the fact they have been net sellers along with our number two holder China. It is not the selling itself that should worry holders of US dollar but rather the implications of such actions. It is highly doubtful that China or Japan will buy any sizeable portion of our Treasuries this time around based on their recent selling, and of course their obvious concern over the USD.
China engaged in swapping 30 year Treasuries for shorter term debt as a way to reduce their exposure to USD. The Fed can only control interest rates for so long and China knows this, which has caused them to change long term Treasuries (most sensitive to interest rates) for shorter term Treasuries (less sensitive).
In other words, it is likely that the Fed will monetize a sizeable portion of our budget deficit, which is a direction injection of inflation.
Conclusion:
I'm not saying that gold and silver are definitely going higher in the very near term, but I am convinced that they will go higher, potentially much higher, by year end. There are numerous catalysts to support this statement, in addition to the bullish price action in the face of a rising dollar, more supply being released onto the market and a Fed attempting to signal tighter monetary policy ahead.
Despite all these headwinds, gold has managed to stay well above triple digits, currently at $1,125/oz as I write this. Silver should behave in an even more bullish manner throughout the year, having the same catalysts as gold but with the industrial demand component being substantially higher in 2010. It is also trading at a meaningful discount when using the gold:silver ratio, up just over 68.
Disclosure:
Author holds long positions in gold, silver, silver futures, SLW, CDE, JAG and FNVVF.PK
Precious metals have been showing signs of an impending breakout to the upside. I'm not one for technical analysis or price action in equities or anything else for that matter, but the current rebound in the precious metals, notably gold, has caught my eye. While gold held its own around $1,100/oz, reaching a low around $1,080, it is currently trading above $1,125/oz.