Gold and Silver Update – December 19, 2013

The big headline today was “Gold sinks below $1,200, the lowest in 3 years”.  Let’s talk a bit about the precious metals, and what this year’s bear market means for gold and silver investors going forward.

Gold closed down $41.40 today to close at $1,193.60. This is the lowest close for gold since August 2010. Silver fell 87.3 cents to close at $19.18 an ounce.

The media in recent weeks have touted all sorts of reasons why gold has performed so poorly this year after 12 years of rising prices:

  • the Fed’s recent announcement that it would begin its “tapering” program and reduce its $85 billion bond purchases by $10 billion a month, thereby signaling an end to its easy money policy that fueled gold’s rise in recent years
  • an improving economy reduces the need for “fear based” assets such as gold
  • a stronger dollar fueled by an improving economy
  • reduced fears of inflation from the Fed’s easy money policy
  • a stock market meltup that has traders selling gold and silver to buy stocks
  • gold was always a poor investment, paying no interest or dividends, and only an irrational bubble sent its price higher in recent years
  • tax-loss harvesting – taking a loss of precious metal positions to offset stock gains
  • fear of deflation

All these reasons, and more, may be valid to explain the precious metal’s price declines.

Here is my take: As interest rates were cut drastically starting in 2007 to combat the financial crisis, and the Fed embarked on its quantitative easing (QE) program, investors feared a rise in inflation and a devaluation of the dollar. These fears culminated in gold’s high price of $1,900 in August 2011.  The Fed then embarked on its third round of easing (QE3), but  interestingly gold did not continue rising, as it had on the previous two announcements.  A weak economy and job market after years of 0% interest rates points to something else – that our economy is battling with deflation.  Gold is typically seen as a hedge against inflation, and with deflation in the picture, gold’s role is now reduced and the price falls. 

There is also the fact that gold and silver rose for 12 years in a row, a feat virtually unprecedented in any market.  It could be as simple as it was time for a break in the price in gold.  But no matter if these reasons are valid or not, the fact is that precious metal prices have been falling for a few years now, and today they have broken a big support area.  The picture has changed, whether you or I like it.

Only time will tell the real reasons for a market’s movements up and down.  Remember, markets act as discounting mechanisms, which mean that they are constantly looking forward 6 to 12 months and discounting the likely outcome.

A savvy investor  always needs to look at any investment without emotion.  Gold and silver investors in particular get fired up about their precious metal investments.  Many are “gold bugs” who look at gold as the savior of our economy’s financial problems.  A return to the gold standard, they argue, would solve the financial problems and debt issues our government currently struggles with.  While a return to the gold standard may be the solution, it probably won’t happen anytime soon, and would only happen if governments are forced to because of another global crisis.

So for whatever reason, the precious metal prices are falling, and sellers are more prevalent than buyers right now.  Let’s take a look at the other side of the coin – for every seller there is a buyer.  Whose is buying all the gold when sellers overtake a market?

TRANSFER OF WEALTH

While investors in North America and Europe suffer from falling prices, other investors are taking advantage of lower prices.  In a recent article, Peter Schiff wrote that Asia’s continued demand for gold could be considered a massive transfer of wealth from West to the East.  Unlike in the U.S. and Europe, Asia has always considered gold to be a store of wealth and a core part of savings.   Consumers purchase gold as bullion (not as paper based investments such as stocks or ETFs), to be held as savings and as a hedge against loss of purchasing power in the official currency.

In recent month there have been record imports and physical gold in China and India.  The gold likely has been flowing from the West to the East.  One of the biggest holders of gold in the U.S., after the U.S. government, is the SPDR Gold Shares ETF (GLD).  This and other gold ETFs have seen a huge outflow this year, from 43 million ounces held at the end of 2012 down to 29 million ounces held as the end of September.  There is much speculation that Asian demand has absorbed this outflow.

GOVERNMENT BIASES AGAINST GOLD

Rising gold prices over the last 12 years definitely caused much concern and public debate over the lack of government fiscal responsibility.  Likely our government is sighing with a bit of relief at the decline in precious metal prices.  A falling gold price is looked at as favorable to our economic situation, and they hope it vindicates the effectiveness of their recent economic policies.

Western governments have always had a bias against gold.  One major reason is that gold acts as a barometer of government manipulations of its currency by currency debasement through excessive printing.  A rising gold price casts suspicion on government economic policies.  So governments historically tend to disparage or refuse to comment on the rise of gold.  They state it is a “barbarous relic” and of no use in modern economics.  In testimonies Fed Chairman Bernanke has said he does not understand gold.  More likely he very well does understand it, but cannot speak freely without repercussions!

I find it interesting that Western governments talk down gold, yet to this day hold a great part of their wealth in gold reserves.  Despite what they say, gold does have a part in world financial and economic policies.  But like with many government policies, official courses of action are often less than favorable to its citizens.  For example, Great Britain sold most of its gold reserves in 2001, right at the bottom of a 20 year decline.  Their official reason was to diversity their assets out of gold which was deemed “too volatile”.   This ranks up there with the Top 10 Most Poorly Timed Investments Of All Time!  There has been much controversy over this sale. Here is a link to an article purporting that the gold was sold to help some major banks and institutions that had big bets against gold.  The U.K. has regretted this sale ever since.

INVESTING OUTLOOK

Now that gold has broken below $1,200 there is a good chance of it falling to $1,000 or below.

Long-term investors like myself are not selling their gold or silver.  I consider them core investment holdings.  I also purchased them below $400 so I am in no immediate danger of prices falling below what I paid – at least not yet!  But yes, it is painful to watch an investment you hold fall in value over the last 2 1/2 years.  Gold hit a high of $1,900 an ounce in August 2011 and has been trending down ever since.

IS THE WHOLE PRECIOUS METAL BULL MARKET OVER?

There is no doubt that we are in a bear market for gold.  Will it fall back to its lows in 2000-2002?  It is very unlikely, in my opinion.  Frequently. bull markets that run over many years have corrections of 50% or more.  And despite the mainstream media’s pronouncements that gold has been in an unsustainable bubble, it never had the characteristics of a bubble.  There was no manic price top and unsustainable fundamentals.  In addition, prices in bubbles tend to deflate rapidly, and we have had a slow decline for a couple of years.

We will keep watching the precious metals markets for developments.  But for now, hold off on all precious metal purchases and precious metal stocks/ ETFs.

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