1 Step Closer To The End Of The Correction In Precious Metals

Includes: GLD, SLV
by: Tim Iacono

Gold and silver prices fell for the third straight week as traders speculated that the Federal Reserve will end its current $85 billion per month money printing program sooner than expected. This bolstered the trade-weighted dollar, a move that often times leads to weaker commodity prices, and important technical support levels were breached for both precious metals.

Along with the rest of the natural resource sector, bullion was already under heavy selling pressure before the release of the Fed minutes due to unsubstantiated rumors of a large commodity hedge fund being forced to liquidate its holdings and a fast-approaching "death cross" sell signal for gold.

Note that, despite the mild hysteria associated with this technical indicator, according to Ryan Detrick of Schaeffers Investment Research (as detailed in this WSJ story) the gold "death cross" is not only an unreliable indicator, but, in fact, a contrary indicator, meaning that higher gold prices are now more likely in the months ahead.

The world's most popular gold ETF saw large outflows, though silver ETFs added to their holdings, as hedge funds continue to reduce their exposure to precious metals and raise their bearish bets. Meanwhile, there was little buying in Asia, however, that could soon change at currently lower prices.

For the week, the gold price fell 1.8 percent, from $1,610.10 an ounce to $1,581.50, and silver tumbled 3.5 percent, from $29.80 an ounce to $28.76. Gold is down 5.6 percent for the year, now 17.8 percent below its 2011 high, and silver moved further into negative territory in 2013, now down 5.2 percent so far this year and some 41.9 percent below its high of almost $50 an ounce 22 months ago.

On Wednesday, the gold price dropped below $1,600 an ounce for the first time since August after details of the Fed's last policy meeting showed that some officials favored ending its bond-buying program sooner than planned.

As was the case six weeks ago when the release of the December Fed minutes indicated a similar sentiment (and markets also reacted negatively), this was again a very misleading take on future central bank policy since the views of hawkish, non-voting regional Fed presidents are given equal weight to members of the policy committee within the minutes.

As detailed in numerous accounts last week (e.g., Fed unlikely to curtail stimulus despite rising doubts), the policy committee remains firmly behind their quantitative easing program, however, the release of the minutes was enough to send precious metals prices tumbling.

Ironically, Wednesday's slide was the biggest one-day drop for the gold price since February 29th of last year when investors also questioned the Fed's commitment to monetary stimulus after a speech by Fed Chief Ben Bernanke.

Since then, the Fed has printed nearly $200 billion to buy assets and, with the launch of the third and fourth rounds of quantitative easing last year, their balance sheet now stands at $3.1 trillion and is rising sharply.

Of course, with U.S. inflation low, the size and trajectory of the Fed's balance sheet doesn't seem to matter anymore.

But, that could change as soon as next month with the February consumer price data that will include a big surge in gasoline prices to go along with a surprising jump in core inflation last month as detailed here last week.

As shown below, as sentiment has faltered, gold is now flowing out of the SPDR Gold Shares ETF (NYSEARCA:GLD) with some 42 tonnes exiting the trust just last week.

(Click to enlarge)

All told, the trust has shed 70+ tonnes of gold since the late-2012 record high and much of this is due to hedge funds exiting the gold market in favor of other assets.

There is some concern that a larger exodus from gold ETFs will spark further price declines, however, as should be clear in the graphic, there is only a tenuous relationship between the two.

Note that the gold price surged to over $1,900 an ounce in 2011 with barely a change in the GLD holdings from 2010 when the gold price was $1,200 an ounce. Moreover, current GLD holdings are now at about the same level as the 2011 peak, though the gold price is almost 20 percent lower.

According to data released on Friday by the Commodity Futures Trading Commission, hedge funds raised their bearish gold bets by one-third in just the last week. While they remain net long the metal, this is a clear indication of how dramatically sentiment has changed in recent months.

This change in sentiment is also reflected in lowered forecasts for precious metals prices by some investment banks.

Goldman Sachs analysts, who said late last year that the gold price would surge early this year, cut their long-term forecast by 15 percent to $1,200 an ounce while lowering their 2013 and 2014 forecasts by about five percent to $1,787 an ounce and $1,744, respectively. Citigroup analysts recently reiterated their view that the 12-year secular bull market in precious metals may now be over, citing a strengthening economic recovery and less safe haven demand.

A more optimistic near-term outlook was provided by Barclays Capital early last week who maintained their first quarter price forecast of $1,710 an ounce and a full-year average of nearly $1,780. Citing tame inflation and a break from the eurozone crisis for the current price weakness, Commerzbank commodities analyst Eugen Weinberg predicted that gold buying will rise sharply in the second half of the year and push prices toward $2,000 an ounce.

As noted here many times previously, I don't lend much credence to any forecasts as they are a much better indicator of current sentiment than future prices.

Though the silver price has been even weaker than gold over the last few weeks, U.S. buyers have not been deterred as shown below via the holdings at the popular iShares Silver Trust ETF (NYSEARCA:SLV). Silver has flowed into this ETF this year, rising by over 100 tonnes in just the last two weeks as the price plunged.

(Click to enlarge)

The world's largest silver ETF has added an impressive 557 tonnes so far this year worth over a half billion dollars.

While this dollar amount pales in comparison to the multi-billion dollar outflows from GLD, the world's most popular gold ETF, it is nonetheless an indication of ongoing strong demand.

It's impossible to know whether we've seen the worst of the price declines for gold and silver, but one thing seems certain - lower prices will attract more buying in Asia and evidence of stepped up demand from cost sensitive buyers in the Far East will soon emerge.

Last week, gold trading volume on the Shanghai Futures Exchange reached a record high as traders returned from the Lunar New Year holiday to be greeted by lower metal prices.

In India, the government is set to announce even more measures aimed at curbing gold imports, however, it has become clear that the only effect this will ultimately have is to decrease the amount of gold entering the nation through "official" channels and increase gold smuggling.

The Indian government banned gold imports from Thailand last week due to the suspected abuse of a technicality that allowed gold jewelry from Thailand to be subjected to just a one percent duty, rather than a duty of between 6 and 10 percent from other nations.

It has become almost comical to watch policy makers play a modern day game of "Whack-A-Mole" as each step they take to curb gold demand is circumvented.

As detailed recently in "The Indian Government's Misguided Effort To Curb Gold Demand", policy makers are getting more desperate with each passing month and, last week's Associated Press story "Baubles to bars: India gold culture defies curbs" is well worth a read for anyone looking for more context on this issue.

Since the bears remain firmly in control of gold and silver markets and bulls are still looking for a catalyst, it shouldn't be surprising to see prices go lower before they go higher, but last week's market action brings us one step closer to the end of this long correction for precious metals prices.

Disclosure: I am long GLD, SLV. 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.

Additional disclosure: I also own gold and silver coins and bars