Precious Metals Pullback Is Inevitable

by: Danny Furman

The first two days of trading this week have featured a long unseen divergence in favor of stocks over precious metals. Strong earnings reports from Ford (NYSE:F) and Intel (NASDAQ:INTC) seem to be major drivers behind the most recent stock market surge. Gold, currently trading at $1501/oz, has held up far better than silver, down to $45/oz after coming withing twenty cents of $50/oz the prior day.

This move in precious metals, as far as I'm concerned, was entirely predictable and does not change the bullish outlook for the sector. In the comments section below a recent article I wrote:

I've been expecting more volatility, but as you mentioned shortages are rampant and there seems to be a strong floor on the spot price. Shorts were piling in around $38-42, I'm curious if they're increasing or decreasing at current levels. If we keep creeping up towards $50/oz some violent selling seems predictable, but if $60 comes around while stocks continue to lag the bandwaggoners will flip flop and the real fun will start. Many expect that to unfold soon, but I think the risk of a US government shutdown coupled with a (perhaps temporary) end to QE, however unlikely, or some other political prank, may be a boon for paper money.

Adding to existing PM positions may not be the right thing for everyone at the moment, but anyone without exposure to them is playing with fire.

As long as people keep waking up and are high-conviction net buyers of PMs, sellers won't be able to keep prices down.

Indeed recent action, particularly in the silver market, has been exciting. As I expected, the largely unhindered climb towards $50/oz resulted in "violent selling" and the white metal is off 10% in just over 24 hours. The primary reasons for selling in silver and gold, off 1% this week, which may continue in the short-term are:

  1. Speculative activity. The stars may be aligned for precious metals, but prices are no longer at extreme historical lows and fast money has been easy to make trading metals and mining stocks for weeks on end. Retail market participants regularly taking leveraged positions and looking for quick profits always breeds volatility.
  2. King Dollar rules the world. Precious metals are making progress towards regaining their status as "money,"but we're not there yet. Businesses worldwide accept fiat currencies created by central banks and a clear move away from the current system has yet to occur. A significant interest rate hike, de-incentivizing speculation worldwide, would take all the wind out of the sails driving stocks and commodities.

In the event of a major rate hike or an instance that induces a similar panic, silver will likely fall quickly and only find support in $5 increments until $20/oz is breached. Support has been phenomenal in gold, suggesting a sudden fall to $30 in silver may correspond to gold pulling back to $1300/oz. Such projections reiterate a deflationary outlook, by which gold, silver, stocks and oil have all benefited in price by unnatural market forces. An end to policy induced US Dollar inflation would leave entitlement spigots dry and allow deflation to strengthen the world's reserve currency.

With fear present in PM markets for the first time in months, a test of $40/oz for silver and $1450 for gold seem likely in the very near term. Investors with dry powder should wait for those levels or a reversal of recent negativity before jumping in. All eyes should be at least partially on the Fed as a rate hike, however unlikely, to historically tight levels of 5% or higher, would likely chop stock and commodities markets in half or worse. Even a temporary a hike or pause in QE would shake markets, crippling asset holders and presenting buyers with tremendous opportunity.

As worldwide political and economic situations remain far from certain, even largely negative, having some money on the sidelines is a must. I expect monetary policy to remain loose and further diminish perceived strength in the US Dollar, and therefore remain bullish on gold and silver. Still, better prices appear to be around the corner and patient investors willing to buy a panic are generally rewarded handsomely.

Disclosure: I am long SLV.