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The Bullion Report

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September 28, 2011 in 'The Bullion Report'

Finding BottomFinding Bottom

Precious metals sold off and sold off hard last week. Gold saw one of the worst price declines in recent memory. Silver shed a large percentage of recent gains, echoing losses seen in the 1980s and sales from earlier this year. Is this the end of the road for these markets? Will this finish the gold and silver bulls? I think the answer is no. 

Past performance is not indicative of future results.
***chart courtesy of Gecko Software

I see many reasons for a potential rebound in gold and silver, but first let's dispense with the key points that likely led to last week's plunge. Things are still a mess across the globe. There have been ongoing attempts to put the brakes on economies that are headed right over the cliff, Greece being the first name that comes to mind. All the chaos in the Euro zone and US spells trouble for investors as confidence plummets. Unfortunately, the tug-of-war between the currencies left many commodities as the real losers last week.

The financial uncertainty caused by debt issues is far from over. The long term picture remains really cloudy in most investors' eyes. How will exports be affected? Will the weakness in developed nations destroy demand for basic commodities? Will this latest round of bailouts and bargaining become a sticky mess that will stall recovery? These proverbial straws are piling up on the backs of equities and other markets and that weight finally pushed things lower last week. Confidence plummeted in markets both at home and overseas. The selloff in the Dow and S&P were just the tip of the iceberg.

Doom and gloom over Greek default led to the drop in the unified currency of the European Union - the euro. The US dollar benefits from that perceived weakness as investors shift into "less risky" foreign currencies. For that time, the US dollar was considered the best of the worst. Its strength was a red "x" on commodities, leading to a sector-wide liquidation of longs. That was only the start of trouble for precious metals.

The overall plunge in markets last week had a secondary effect. Investors and funds that lost money when things nosedived needed to get liquid fast to cover margin calls. Since some precious metals holdings are likely still up year-on-year, they become the go-to asset for selling when someone needs to raise cash. This was the probable cause behind one of the sharpest declines in gold prices since the 1980s. The same thing has happened on a micro level with consumers. Things have been so bad for so long, in terms of a delayed recovery from the initial collapse in 2008, that really only one place has stood as a temple in which to try to preserve assets. In my eyes, people are tapping into their final bastion of investment to hold on and cover other losses as financial chaos continues.

The other monkey wrench in the works was another round of margin rate hikes, one from the CME Group and at least one other on the Shanghai Gold Exchange. These performance bond increases can do two things: they can shake out smaller investors or weak longs, and they can serve as a potential motivator for profit taking, since the return-on-margin calculations might paint a less desirable picture. This is especially true when there are other clouds on the horizon - some funds and bigger investors might just want to sit on the sidelines as everyone works on their balance sheets.

 

Summary

Whatever the motivating factors, there seem to be more than a few people looking to dip their toes back in this week. Bargain hunting will be the name of the game and that is where markets like gold and silver can hope to find support. The weakness in both markets was not due to fundamental factors like a large gold sale from a central bank or a weakening demand scenario for physical bullion - they were just caught in the same downward spiral as other commodities. Has the gold haven been breached? I don't see it that way. In fact, the continuing volatility and bailouts and uncertain future make me think this is just another bump in the road - a healthy correction, if you will. The idea that most investors were pulling out to get cash to cover other losing assets just reinforces this notion. Gold and silver are probably going to recover from this, and that is more than I can confidently say about certain economic issues at the moment.

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Disclaimer: The prices of precious metals and physical commodities are unpredictable and volatile. There is a substantial degree of a risk of loss in all trading. Past performance is not indicative of future results.