Gold & Silver Price Under Pressure, US Dollar Perceived Safe Haven

As a consequence of the 5-year monetary stimulus from the US central bank, the US dollar recently came out as the safe haven currency. Undoubtedly, that was one of the key objectives of the central bank. Add to it the fact that gold has lost its “safe haven” appeal, and you have an outcome that probably is the best of all worlds, at least from a central banking perspective. The message that this trends carries – at least for now – is that the US dollar deserves to be the world reserve currency; it is the strongest of all currencies.

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Whether this trend is based on strength of the US dollar, based on a strengthening economy, or whether it is the result of the weaking of all other currencies, does not matter for now. Lately, the disconnect between economic conditions, stock market and value of the US dollar has become too blatant. From the latest GEAB report:

There is no shortage of indices that point to a worsening of the economy. Europe is already in recession. Exports from China, often considered “the workshop of the world”, are falling heavily (see chart below) and the benchmark signals are contracting or slowing down dangerously with, additionally, a major credit bubble. Australia, which gives a good indication of the world economy’s health due to its exposure to raw materials, is struggling. Consumers are also marking time. US wholesale and retail sales are on the decline. The majority of US benchmark indices are swinging into the red, for example the Chicago PMI index, as well as the Goldman Sachs global index. In short, a world recession is on the horizon. To protect themselves from its impact, the different players, beginning with the banks, use different strategies which we will now analyse.

Equities and US dollar soaring on air

For now, the market has made its decision: the equity markets and the US dollar are the place to be. The underlying economic fundamentals are either being ignored, either being seen as positive. This makes sense to some extent, as in a zero yield world equities could indeed be a good option.

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Dan Norcini writes:

With nearly every single passing day bringing us yet another new lifetime high in US stock markets, the pattern is clear – institutional money, and hedge fund money, are buying equities in what they now firmly believe is a NO LOSE SCENARIO.

The Fed has managed to annihilate the very concept of “RISK”. If anything, the only risk that now exists is the RISK OF NOT BEING IN the STOCK MARKET and angering your clients who are sure to take their money elsewhere. Money has no loyalty – it goes to where it can gain the largest yield and all money managers understand this. If they wish to retain their client base, they must chase stocks, whether or not they want to. Again, this is just  a reminder, they are not investing client money – they are trading it.

We are living through monetary history. Others coming behind us are going to pour over this period that we are privileged to be first hand participants in trying to come up with explanations for this speculative frenzy in equities that we are now experiencing. Mark it well and remember it; you can tell your kids and grandkids what it was like to watch an entire generation collectively lose their minds and throw caution out of the window. This is what ZERO YIELD environments produce.

The contradictory thing – although it does not matter in the markets – is that commodities are moving lower. That really does not match with a positive economic outlook. The outlook reports from the large banks are based on the assumption that the debt situation will not worsen and that the economy will improve. Well, in such a scenario commodities should be in higher demand, pushing prices higher.

Moreover, in the last months and weeks, both lumber and copper have been pushed down. Lumber has a connection with the housing market, while copper signals strength of global economic conditions. The move lower of both commodities does not confirm an improving economy. So either commodities either equities are moving on air.

Also, the mania in the stock market could cause money to leave the bond market, which should send bond prices lower and interest rates higher. Indeed, that implies inflation and increasing debt servicing costs. That is the price to pay for a mass entrance in the stock market.

What do we make out of this? For now, it seems that the artificial world created by central banks the equity markets and the US dollar have a too strong appeal to investors, ignoring whatever reality or fundamental economic conditions. Ignoring also unintended consequences of the ongoing trend. Quoting again Dan Norcini:

With the US Dollar soaring higher, with consumer sentiment ramping up towards the economy (no doubt the precisely desired outcome by the Central Banks when they created the perfect conditions for a bubble in the equity markets), consumers are feeling the wealth effect which comes from seeing their pensions and other retirement plans increasing nearly every single day, while at the same time poor demand for unleaded gasoline has sent prices dropping at the pump. Hey, what could be better than this?  My investments are soaring, my costs are the gas pump are dropping and my food bills are even going lower, is the thinking of the average consumer out there right now.

You have to hand it to the Central Banks; they appear to have made fools out of the honest money crowd and upended the laws of economics and the very theory of money itself. Apparently we can have our cake and eat it too. All we need to do is to have the Central Banks create unlimited amounts of paper money and we can forego any concerns whatsoever about debt.

When and how will this end? Impossible to predict, simple as that. So be aware the charlatans predictions (in both directions). As far as the “when” question is concerned, what we do know is that manias usually take (much) longer than expected. Look at the .com, the housing or any other bubble that was disconnected from reality. As far as the “how” question is concerned, the tendency is that they end badly.

Gold & silver price under pressure, demand sky high

The pressure on gold and silver prices comes mainly from investors going where the money is moving into. The market participant who is searching for yield is not to be blamed. The monetary role of the metals is totally ignored right now, whether fair or not, whether you like it or not.

For traders, it is critical to act according to this reality (which they did in masses in the past months). By contrast, value investors who are looking to protect their assets from monetary destruction look at it differently. They do not ignore the ongoing global currency war. They prefer to hold bullion too early than too late. The price to pay as an investor is to see the gold and silver price going down, pushed by soaring US dollar and equities. As we all know, the dollar and the stock market as inversely correlated with gold.

Until an event of major significance occurs, supporting the monetary value of the metals, it is very likely that prices will be pushed down. Now here comes the major disconnect. The lower the prices are moving, the more likely the physical metal will be absorbed by value investors looking for monetary protection. We saw how it played out since the price crash of mid April. So what is a likely outcome if this trend continues? There is a chance with a significant probability that the gold and silver price will reach a point where traders are willing to come back, but where the world will be short of metal.

Currently, with a lower gold price and silver price, it becomes increasingly unproductive to mine the metal. If this trend continues, the likely outcome is that the mining sector will not be willing to invest in new discoveries. New mine supply is not significant compared to the existing above the ground metal. It does matter, however, when there is an underdelivery of new metal, given a very strong demand for it.

In such a scenario, holders of physical gold and silver will see a revaluation by the market and prices will react accordingly. Investors who are selling right now could have very hard times buying the metal, because of too high premiums.

Conclusion

Taking all this together, where does it leave the gold and silver investor? What follows is our personal view – it is in no sense financial advice or a prediction of any kind:

  1. As there is no significant yield elsewhere, equities and US dollar could have a long way to go before they correct. Hence, gold and silver could see a long way down, before they reverse.
  2. Gold and silver investors should think about the reasons why they are holding the metal. If it is for monetary protection, then they should be able to ignore short to mid-term price action, even if the price will go lower. It is an option to hedge the metal, according to personal preference and investment experience. As the ongoing trends are not driven by fundamentals, the need for monetary protection should become even greater in the future.
  3. We are living in unprecedented times. It implies that the script for the future has not been written, and nobody knows what is next. There are too many contradictory signals out there right now. Participants in the ongoing uptrend should be careful.

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