In my previous article I pointed out how important it is to follow the capacity utilization rate to estimate the prices of gold and silver going forward. When the capacity utilization rate plummeted in 2008, we knew for sure that commodities would plunge with it. So what happened recently?
The capacity utilization rate for total industry for April 2012 came out at 79.2%, up from 78.4% the previous month (Chart 1). This number is the highest since July 2008, and bodes well for commodity prices, especially gold and silver (which had a very significant correction in the last months). Both mining, utilities and manufacturing came out higher in capacity utilization than the previous month. There was a concern the previous month that capacity utilization would come down in April, but it didn't. So gold (GLD) and silver (SLV) prices should find support in the coming months.
|Chart 1: Capacity Utilization Rate|
The first bullish sign is that since May 14, 2012, gold and silver turned to backwardation. As I discussed in this article, backwardation is typically a bullish sign for that particular asset class. This is especially good for the gold price, as this precious metal normally is in contango if we look at historic contango-backwardation reports. This is due to the nature of the gold commodity and constantly high supply. Gold commodity, opposed to other commodities, is never fully consumed but rather gets re-circulated, taking on various forms like coins and bars. If gold futures turn to backwardation, there is tight supply. I would argue that China and central banks buying record amounts of gold might be one reason this backwardation is occurring.
Another bullish sign for gold and silver prices is that lease rates have been steadily increasing (Chart 2 and Chart 3). Of note is that the 3-month silver lease rate went back above 0%. This trend is pointing to the fact that central banks will ask a higher yield to lend their gold and silver to bullion banks. Bullion banks will have to buy back their sold gold and silver when lease rates keep going up.
|Chart 2: Gold Lease Rates|
|Chart 3: Silver Lease Rates|
The recent price decline in precious metals could be attributed to investors getting out of the euro and back into the dollar, which supports USD strength and commodity weakness. Lately, the U.S. dollar has been strengthening its status as a reserve currency (Chart 4), as investors have been rebalancing their investment portfolio due to the European sovereign debt crisis.
|Chart 4: World Foreign Exchange Holdings|
But several analysts, including Marc Faber and Michael Pento, recently predicted that the federal reserve will be implementing QE3 as soon as possible. It's just a matter of time. Marc Faber said QE3 would certainly come if unemployment were to deteriorate. Michael Pento in particular mentions only two outcomes, either QE3 will be implemented, or we will face another crisis bigger than 2008. We can already see the start of the crisis now with European banks hitting new lows and European government bonds hitting record bond yields. Therefore Michael recommends to start buying mining shares in precious metals in anticipation of QE3.