What's Behind the Move in Gold and Silver Prices?

by: Daryl Montgomery

The euro rescue plan announced pre-market Monday morning has yet to calm jittery financial markets. Gold hit a record high yesterday on rumors that Germany was planning on leaving the currency union and going back to using Deutsche marks. Silver has benefited from a U.S. government investigation of JP Morgan (NYSE:JPM) and its possible manipulation of global silver trading.

Gold has been rising for several years now against all major paper currencies and this indicates a massive global devaluation of fiat money (currencies that are not backed by hard assets) is taking place. We are still only in the early stages of that devaluation. When the Greek debt crisis surfaced, gold fell from December to February. Superficially, this makes sense because gold usually trades with the euro and the euro was dropping. After February, gold recaptured its usual safe haven status and started rising as the euro continued to fall. The trade-weighted U.S. dollar was of course going up at the same time. The dollar is also traditionally a safe haven whenever there is a crisis in the world. In this case, though, the dollar is hardly more sound than the euro and a good case can be made that U.S. government's finances are even worse than Greece's.

There is no question that the euro currency union cannot continue to operate the way it has up to this point. When the eurozone was created, there seems to have been no consideration of how matters would be handled if problems arose - a truly amazing lack of foresight. The Greek debt crisis also revealed that the eurozone authorities were unwilling to take necessary action to enforce the standards supporting their currency. Greece lied to the EU about its fiscal position for years and its budget deficit to GDP ratio for 2009 is more than four times what is permissible by currency union rules. If this doesn't get it thrown out of the union, it appears that nothing could ever happen that would get a country removed from the eurozone. This is how the rumors that Germany would withdraw from the euro could take hold and gain some credence. At this point in time though, there is a zero percent chance that this would take place. Such an action would create a crash in the world financial system that would be much greater than what occurred after Lehman's collapse. The authorities are well aware of this.

Silver, which trades with gold, has its own unique issues. News sources on May 9th reported that parallel civil and criminal investigations had been launched into whether or not JP Morgan has engaged in manipulative practices to keep down the price of silver. The CFTC (Commodities Futures Trading Commission) is looking into civil charges, and the Department of Justice's Antitrust Division is handling the criminal probe. The CFTC has had complaints for years that a few big banks were manipulating silver prices, but just as the SEC ignored complaints against insider Bernie Madoff, the CFTC paid no attention. The CFTC hearings this spring on the silver market blatantly exposed the corrupt practices taking place. Nevertheless, the mainstream media ignored the story (just as a number of press outlets had the Madoff story for years, but failed to publish it). The hearings did get a lot of attention from blogosphere and on YouTube, however, and this may have finally put enough heat on the CFTC to take action.

From a technical perspective, gold has broken out from a cup structure (without a handle). Going to new highs is always a sign of strength. Gold price action is being fed by, and is in turn feeding, a great deal of bullishness. Too much bullishness, though, is not a good sign. The dangers for gold are a recovery in the euro (which is extremely oversold) and the market gaining some confidence in the bailout. The situation in Europe is likely to calm down into the summer. In the long-term problems will resurface however. Investors should also keep in mind that the IMF has a lot of gold and has decided to start selling it to pay for its programs (such as the euro bailout for instance). These sales can cause gold to experience a sharp and sudden price drop.

Investors can purchase gold and silver through ETFs (exchange traded funds). Gold ETFs that hold physical metals include GLD, IAU, and SGOL. Silver ETFs include SLV, USV and SIVR. The euro ETF is FXE and the trade-weighted dollar index is DXY.

Disclosure: Not relevant.