Gold (GLD) and especially silver (SLV) have succumbed to a long and demoralizing correction over the last 12 to 18 months. The summer doldrums likely marked the bottom of this correction, and the metals have turned the corner higher. However, both gold and silver investors will likely have their resolve tested once again in the coming weeks before the metals are able to break higher.
Precious metals and mining equities surged from their 2008 lows to their 2011 highs in reaction to massive monetary intervention and an initial surge in inflationary expectations. Although interest rates have remained near zero, and real interest rates are clearly negative, precious metals investors have been disappointed by the ongoing global stagflationary wealth destruction, and the failure of further intervention by policy makers. The Federal Reserve has admitted that the US economy is weaker than desired, yet it has also continually disappointed in announcing a new quantitative easing as it seeks political justification.
The last two years of global policy makers kicking the can down the road, in conjunction with weaker demand from India, has created the environment for a severe correction in gold, silver and miners. While it hasn't been the most severe in terms of percentage loss, it has likely been the most severe in terms of sentiment. With Europe, India, China, and the US all decelerating at a rapid pace, and the US fiscal cliff returning the political forefront, we believe that we are months away at the most from a turn in monetary policy. Verbal intervention has run its course, and real monetary intervention is a mathematical certainty.
Gold miners (GDX) bottomed in May, and are leading the metals. They are now overbought and could face a sharp correction before breaking out.
Gold and silver may already have begun pricing in future intervention; however, commercial banks are not yet on board with the breakout in gold and silver. Net commercial short positions in both gold and silver, at a time when prices are near resistance levels and overbought, are indicating that a short and severe correction could be imminent.
Silver has had an especially large spike in commercial short positions over the last three weeks.
The current commercial short positions in silver and gold must be reduced before the metals can break higher. In other words, commercial banks must cover the majority of their short positions. While they could cover as prices rise, history suggests that the most likely scenario is for the commercial banks to take down the price and cover at lower levels. This correction will likely coincide with the realization of a global recession/depression in 2013 and end with the realization of further monetary intervention.