More Dollar Weakness Could Send Precious Metals Much Higher

 |  Includes: GLD, PSLV, SLV, UUP
by: Tim Iacono

A weaker trade-weighted dollar combined with strong demand from ETFs, hedge funds and emerging market central banks to push precious metals prices sharply higher last week.

Silver turned in its best week in two-and-a-half months after surging nearly 80 cents per ounce on Friday. The silver price, along with gold, broke through important technical levels, setting the stage for what could be a spectacular finish in 2012, that is, depending upon what elected officials in Europe and Washington do in the weeks ahead as they wrangle with the issues of sovereign debt and budget deficits.

For the week, the gold price rose 2.2 percent, from $1,713.70 an ounce to $1,751.90, and silver jumped 5.6 percent, from $32.31 an ounce to $34.13. Gold is now up 11.8 percent in 2012, down 8.9 percent from its high last year, and silver is 22.5 percent higher this year, down 31.1 percent from its early-2011 high.

As noted in this item on Friday, the Thanksgiving holiday can be an interesting period for precious metals markets as U.S. traders are largely absent and commodity exchanges in the rest of the world are left to determine the price of gold and silver.

While there is no guarantee that the big move higher for both metals will continue, it's worth pointing out that there is some correlation between what happens on these two trading days and what happens during the rest of the year.

Last week, gold and silver prices both jumped above their 50-day moving average for the first time in over a month and this could lead to another test of the $1,800 an ounce level for gold and the $35 an ounce mark for silver.

The recent surge, combined with more talk of money printing by some central banks and more evidence of gold buying by other central banks, has market participants very bullish as shown below via Kitco's weekly survey of bullion dealers, investment banks, traders, and technical analysts.

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This bullishness showed up in precious metal ETFs where holdings recently reached new record highs. Though the SPRDR Gold Shares ETF (NYSEARCA:GLD) was about flat last week at an all-time high of 1,342 tonnes, total gold-backed ETFs rose to a record 2,605 tonnes according to Bloomberg. A separate tally of the 34 gold funds tracked by Commodity Online showed record holdings of 2,733 tonnes as buying has been steady, not spectacular, down from last month's pace.

Silver ETF holdings also set a new record despite consecutive weekly outflows of 122 tonnes and 136 tonnes from the iShares Silver Trust ETF (NYSEARCA:SLV) that now stands well below its 2011 highs. According to this Hard Assets Investor report, overall silver ETF holdings rose to an all-time high of nearly 19,000 tonnes last week, surpassing the level of April 2011 when the silver price peaked near $50 an ounce.

The Sprott Physical Silver Trust (NYSEARCA:PSLV) was responsible for some of the recent increase in world-wide silver ETF holding as, according the latest data at the company's website, they now own over 1,500 tonnes of the metal. Unfortunately, since this is closed-end fund, the additional supply of silver has helped to push the fund's premium down to a record low of just 0.77 percent. While it's possible that this could go even lower, there is now tremendous upside potential for PSLV as its premium has been as high as 30 percent in the past.

Emerging market central banks continue to swap out other assets for precious metals and, according to the latest IMF data, Brazil was the biggest gold buyer in October with a 17.3 tonne addition to their reserves, representing an increase of nearly 50 percent. Overall, this group boosted their gold holdings by over 40 tonnes last month and they are on track to meet or exceed last year's multi-decade high of 455 tonnes in gold purchases.

As emerging market central banks buy gold, central banks in the U.S., Europe, and Japan ponder how much more money they'll have to print to provide aid to their faltering economies and this has been the single most important driver of gold and silver prices in recent years.

And when it is the world's most important central bank doing the money printing, that can translate into dollar weakness that helps drive gold and silver prices higher.

That dynamic was on display again last week as better-than-expected economic news from Germany and China combined with hopes that Greece's creditors can agree on a new bailout deal, sending the trade-weighted dollar lower and lifting both the euro and gold.

As shown below via BigCharts using the GLD ETF and the PowerShares DB US Dollar Index Bullish (NYSEARCA:UUP), there is a strong short-term correlation between these two assets as areas highlighted in green indicate a rising gold price/falling dollar and areas highlighted in red show the opposite.

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From week-to-week, it's often difficult to discern any relationship between the two, but two things are clear in the chart over the past year - when the dollar undergoes an extended decline, the gold price rises and when the dollar undergoes an extended rise, the gold price falls.

Dickering in Washington over how best to avoid the "fiscal cliff" could see last week's dollar reversal quickly transform into an extended move lower and, when considering that the Federal Reserve is likely to announce another $45 billion in outright money printing when they meet in two-and-a-half weeks, the dollar's declines could accelerate. Of course, new money printing efforts in Japan, the U.K., and mainland Europe could limit the dollar's decline.

Government officials in India certainly seem to be doing everything they can to limit the amount of gold the Indian people hold, encouraging them instead to buy paper assets, and this has been one of the more interesting, ongoing stories in the gold market in 2012. Last week, the Reserve Bank of India directed banks not to give loans for purchase of gold in any form, including primary gold, bullion, and jewelry.

This is their latest effort to reduce their trade deficit that, primarily, is the result of huge gold imports that topped 1,000 tonnes last year and was valued at over $60 billion. I doubt they'll be successful in this effort as the Indian people have a cultural affinity for the yellow metal that, importantly, has outperformed just about every other asset class over the last ten years - but they'll probably keep trying.

Disclosure: I am long GLD, SLV, PSLV. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article. I also own gold and silver coins and bars.