Precious Metals: Value Buy, Money Pit Or Apocalypse Now?

by: Emmet Kodesh

Federal Reserve Board Chair Bernanke must have waved the wrong wand Tuesday evening when he spoke at the National Economists Club annual Dinner. He stated that the Fed's target prime rate would remain zero and that "a preponderance of data" on economic recovery would have to precede an end to "accommodative" policy, mainly purchasing T-Bills and MBS. Since ZIRP helps only the housing market and does nothing to repeal Federal anti-jobs and anti-growth policies, the economy never will recover and QE will continue till and beyond the end. Yet the 10-year yield rose 8 basis points today to 2.79%.

The promise of endless debt creation and liquidity prompted the markets to open with a small roar: the S&P rose above 1795 at 10:20 a.m. Alas, speculation that tapering might start in February or March blew down the Street at 2pm with the FOMC minutes and the S&P fell to 1777 before closing at 1781. As usual PM (precious metal) bullion and miners were first overboard but that action began before the open with a plunge in spot bullion. What should PM investors do other than patiently endure the storm?

Strong hands seem to have decided that news of continuing free money for banks would not be allowed to prompt investment in PMs. Gold dropped at 6 a.m., again at 9 a.m. EST, and fell with the equities from $1262 to $1242 in mid-afternoon. Silver, too must have lost all its utility since it fell to $19.80 / oz. before closing at $19.86. This was notable because $19.95 is a 75% retracement of the August rally. The fact that PMs can hedge against currencies vitiated by debt seems to have dissipated amid negative sentiment. One must acknowledge this trend however strong PM basics are and however shaky our economic order is. Moreover, PM supply is not expected to drop significantly till 2015 when current cuts in capex take effect. Sustained upward pressure on pricing may be awhile in developing. How patient are you able and willing to be? Do you see a better risk/reward in equities?

Since September I have been suggesting that the ability of government and its financial and media enablers to shape Western markets and sway investors and consumers is nearly inexhaustible. In a Nov. 19 interview, John Hathaway, Senior Managing Director of Tocqueville Funds made a similar point. The manipulation of PM prices is merely one of the more extreme examples: another, so familiar it is hidden in plain view, is the use of QE to manage the bond and housing markets as Mr. Bernanke indicated. With a cyclical PM bear market strongly entrenched (gold's 200-day MA still is falling and recent prices are pulling it lower), does this mean one should significantly sell down PM holdings?

Robin Griffiths of Cazenove Capital, stock brokers to the British Crown, believes that the secular bull in PMs remains intact. "There is no doubt that the secular uptrend is still in place" he states. He argues further that the relative decline of Western vs Eastern economies is a primary fact of this century, that it will increase and that PM buying in China and India and devaluation of Western currencies insures that by the end of 1Q 2014 gold will break $1900 / oz. and reach $2400 by year's end. While the macro situation makes this scenario plausible, I am more impressed, and not only in the short term, by the point I and Hathaway have made: gaming the system will continue and major wealth consolidation events are likely. The shift of resources to the East is only one aspect of this take-down of Western societies: making health care a business governed by bureaucrats is another. Extension of government powers is a concern in other socio-economic matters.

PM companies do not have to sell their ore concentrate at ridiculously suppressed prices. They can invest in short-term instruments and those with clean balance sheets like First Majestic (NYSE:AG), Endeavour (NYSE:EXK), McEwen (NYSE:MUX) and Fortuna (NYSE:FSM) can borrow a bit to finance operations while continuing to sell bullion into the retail market. To date they have been supporting revenues by increased production: the pain is from falling bullion prices. With a slowdown in recycling and new supply, upside pressure on prices will increase, even if slowly: the push of heavy buying (2013 already has set a record for sales of Silver Eagles and Maple Leafs) will fuse with decreased supply to hinder if not overcome price suppression via naked shorting and other maneuvers.

To the extent that one accepts these views, patience and limited buying of miners and bullion ETPs like Central Fund (NYSEMKT:CEF) and Sprott Physical (NYSEARCA:PSLV) are reasonable plays. However, the scale of artifice in governance and finance means everyone should limit their bets on outcomes and asset classes: the lower your net worth or risk tolerance, the more you should limit sector overweighting except in health care (NYSEARCA:VHT), +.36% today and +41% in 52 weeks. Artificial interest rates coupled with Sovereign debt makes bonds a high risk -low-return choice, so underweighting there still seems right.

The UK Financial Conduct Authority, FCA, supposedly is investigating those who set and trade benchmark prices in gold. This prominently includes the famous twice-daily London "gold-fixing" that is managed by five major banks. The participants use current sell and buy orders to set or "fix" an average price. This enables strong hands to place huge sell orders pre-market when there are no or few buyers which drives down the initial fix. This helps explain some of the frequent daily plunges at the NYSE open. Retail holders and sentiment are crushed while buying by major players, not least China, is facilitated. The process is a rinse and repeat, seemingly ad infinitum. It is notable, however that while fund managers Seth Klarman and Leon Cooperman have sold their miners, George Soros has kept Barrick Gold (ABX) and bought the Gold Miners (NYSEARCA:GDX) while exiting Goldcorp (NYSE:GG) and Junior Miner (NYSEARCA:GDXJ) positions. Perhaps Soros shares my views on ABX.

This month a gold vault that can hold 2000 metric tons of the metal opened in Shanghai to handle part of China's enormous Sovereign and retail purchases of gold (they too have a major interest in depressed prices, for now). The vault is owned and run by the Hong-Kong based Malca-Amit Global. Consumption in China has risen 29% this year and with India, Indonesia and Vietnam it now accounts for 60% of the global market, doubling its share in 9 years. This confirms what I and others frequently have noted about the shift of gold and power, monetary and other from West to East, a process facilitated by Western Banks. Official figures state that China imported 826 tons of gold during the first nine months of 2013 (see previous link).

This trend portends a powerful rise in PM pricing and the velocity of the shift to the East suggests that Griffiths, cited above, may be right in believing strong price accretion will start in 1Q 2014 and with it a resumption of the secular bull in PMs. Just remember, it is unclear the degree to which those who have been crushing gold prices will allow retail investors to share in coming gains.

On Monday afternoon, Carl Icahn stated that the markets were overbought and headed for "a big drop." The indices duly plunged: in an hour the S&P, which had topped 1800 shed 10 points and the DOW fell from its peak above 16,000. Perhaps he wants to catch a dip: one is coming . It is possible that by timely infusions of QE mixed with taper talk the Fed may be able to keep us on a regimen of bimonthly 4-5% mini-corrections, a pattern about which I wrote here. This being said, I also see in the carefully managed markets a significantly overbought profile since the rise from the October 8 intraday low of 1646 being bled only a bit since Icahn's comments and taper speculation.

The indices could correct to S&P 1700-1720 without breaking the established lower line of the up-channel. Unless we have entered a new financial regime (and it does not look like we have, nor that the economy has), a correction in the next four weeks is likely. As I have been suggesting for almost a year, one needs to continue to nibble at equities but at this point, wait for a couple of red days or a drop of at least 150 points on the DOW to add. Particular stocks of course have their own dynamics. Those who bought British Petroleum (NYSE:BP) at $41 when I first began suggesting its merits are glad. Since I first noted Boeing (NYSE:BA) as a long term stalwart it is +62%. Results also are good for those who bought CBS (NYSE:CBS), Disney (NYSE:DIS) or Time Warner (NYSE:TWX) when I began attending to them here and again here.

The upshot is that most people have reason to shun the PM sector: many already are overweighted or have positions as great as or greater than they can stomach. For someone with little or no exposure, this is a good time to build an allocation of 5-10% but history suggests the latter is a maximum portion for most people. Be ready to watch your holdings go up the down staircase repeatedly and to be baffled by incongruity between industry and supply-demand fundamentals and pricing.

The macro-context for PM decisions was succinctly put by Larry Summers recently who noted that QE has created asset bubbles far beyond any positive effects it has had on the economy. ZIRP he said, "is a chronic and systemic inhibitor of economic activity." As I've often written, QE in effect was adopted to permanently cripple the economy.

This being said, the mid-long term case for strong accretion in PM bullion and miners remains intact. The climax of fiat governance insures it even as it suppresses prices and creates buying opportunities in the short term for those who can afford to hold and be ready to trim gains. What has been done to PM prices is a taste of what is being done and will be done to society generally: a crushing of natural activities. A variety of defensive moves is needed to protect against this process.

For those who have had enough punishment, try to wait for a recovery from the recent carnage to trim PM positions. Note that Vanguard Natural Resources (NYSE:VNR) which I often have commended for its low 'r' and 9% yield (paid monthly) rose 1.21% November 20, a day of general declines pushed by speculation and overbought conditions.

Disclosure: I am long EXK. 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.

Additional disclosure: I own PM companies individually and in a diversified fund.