Will Gold And Silver's Rally Reach A Halt?

Includes: ABX, GG, GLD, SLV
by: Lior Cohen

The prices of gold and silver spiked during August to their highest levels in recent months. Looking forward, will gold and silver continue their upward trend? Let's examine the latest developments that may affect the progress of gold (NYSEARCA:GLD) and silver (NYSEARCA:SLV) prices.

FOMC Meeting and QE3 Tapering

A lot of guesses have been made in the past several months regarding the Federal Reserve's next move. The speculations have started after Chairman of the Federal Reserve, Ben Bernanke, first introduced the idea that the Fed may start tapering QE3 in 2013 and end it in the first half of 2014. Since then, analysts and precious metals investors tried to figure the Fed's next move by examining the progress of the U.S economy: If the U.S shows signs of progress, the chances of the Fed tapering QE3 rise. Last week's, U.S non-farm payroll report didn't meet expectations even though the number of jobs added was well above the natural population growth. Despite the slow progress of the U.S labor force, many analysts still think the Fed will start cutting down its asset purchase program in the forthcoming FOMC meeting, which will be held on September 17-18. If the Fed starts tapering QE3 this month, this could curb down the recent rally of gold and silver. But even if the Fed doesn't cut down QE3, I don't think it will be enough to pull back up gold and silver prices.

The chart below shows the developments in the U.S money base and monthly average price of gold between 2010 and 2013.

(Click to enlarge)

As seen above, soon after QE2 started, both gold price and U.S. money base sharply rose. Silver, much like gold, followed and also spiked during that time period. On the other hand, after QE3 was launched back in late 2012, the price of gold changed direction and declined. At face value, this could suggest the rise in U.S money base didn't steer investors towards gold and silver. Perhaps the fear of rising inflation has diminished; or the sharp rise in long term interest rates have reduced the demand for gold and silver. In any case, this means even if QE3 continues, the prices of gold and silver won't resume their sharp upward trend.

So what could keep gold and silver prices high?

The rise in physical demand for bullion in Asia including China and India could keep gold and silver prices from tumbling down: China's consumer demand grew by 87% in the second quarter of 2013; India's consumer demand rose by 71% during the quarter (year-over-year).

Another factor to consider is the rise in production cost, which could eventually reduce the supply growth of gold and silver. E.g. Goldcorp's (NYSE:GG) all-in cash production cost reached $1,279 in the second quarter of 2013 - a 21.5% gain compared to 2012; Barrick Gold (NYSE:ABX) all-in sustaining cost is projected to range between $950 and $1,050 per ounce in 2013. These high rates could eventually lead to a drop in growth in mining projects, which could curb down the rise in bullion supply.

Take Away

Based on the above, I think gold and silver's recent rally won't last long. Even if the Fed doesn't start tapering QE3 in the coming months, this won't be enough to keep gold and silver prices sharply rising. Nonetheless, the ongoing increase in the demand for physical gold and silver in China and India along with the lower margins of leading gold producers could maintain precious metals prices from plummeting.

For further reading see: Gold and Silver Outlook for September

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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.