There have been bullish and bearish weeks for gold and silver. Last week was a bullish one.
Both metals ended the week on a higher note, with gold closing well above $1300, gaining close to $100 so far in 2014. Silver followed suit, hovering around the $21 mark. SPDR Gold Shares (NYSEARCA:GLD) gained close to 5% for the week, racing closer to the $130 mark. iShares Silver Trust (NYSEARCA:SLV) gained close to 4% -- both funds testing key support levels.
Is this bullish sentiment sustainable?
We cannot say. What we can do is explore two factors that could re-ignite the precious metals rally.
First is the resumption of inflationary expectations, the ultimate driver of precious metals prices over the long-term. Such expectations are nowhere to be found, however -- especially in the developed world.
In spite of unprecedented accommodative monetary policy, inflation in US and Japan remains tamed, while Europe is teetering on the edge of deflation rather than inflation. Most notably, wage growth, which usually feeds inflationary expectations, remains tame. And capacity utilization, a factor that affects wage growth, remains sluggish-below 80 percent in the US.
Simply put, gold bugs shouldn't expect any help from inflationary expectations, at least not in the near future.
Second is the revival of sovereign debt concerns. This time around, the epicenter of the next debt crisis may be in Asia rather than Europe. In an article published recently in Barron's, for instance, Carl B. Weinberg expects Japan to go over the cliff. "Elementary economics suggests that Japan's reflationary policy is about to fail. Abenomics is leading the country into recession, high debt, and a trade deficit."
That could revive demand for the two precious metals. Investors could rush out of Japanese treasuries, as was the case with European treasuries two years ago. Nonetheless, the size of such trade could be enormous, given the clout of the Japanese economy.
Last but not least is the growing the US-China conflict in the Asia-Pacific region, which may induce China to sell off US Treasuries, and buy gold with the proceeds.
In fact, China is another country with looming sovereign debt problems. Though the country continues to expand at healthy rates, momentum is ebbing -- as the Chinese government begins to crack down on the shadow banking system, which provided fuel after the 2008-9 global crisis.
"Shadow banking presents an especially difficult challenge," write Lingling Wei, Bob Davis and Shen Hong in a recent piece in The Wall Street Journal. "On one hand, Beijing wants to encourage the development of non-bank financial institutions, which often lend to smaller firms that are overlooked by China's biggest state-owned banks ... On the other hand, the rise of shadow banking has been a major reason that debt has increased at a pace similar to the US, Europe and Asian nations before they crashed."
How likely is each scenario?
It is hard to say. What we can say is that sovereign debt crises can be hidden much longer than we tend to assume, especially for large economies with their own currency. But they create havoc in global markets when they break out, fueling precious metals rallies, as investors flee ailing currencies.
Compounding the problem, the breaking of an overseas sovereign debt crisis could prompt the Fed to abort its on-going tapering program, a bullish scenario for gold.
What does all this mean for investors?
Take a gradual approach. Accumulate precious metals rather than chase after them. And monitor closely the Japanese and the Chinese economies, watching for events that may cause a Greek style crisis.
Disclosure: I am long 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.