Gold and Silver's Firmly Established Trends, For Now

Includes: GLD, SLV
by: Daniel Zurbrügg

Since our last update in February, when gold was trading around USD 1330, the price has moved up to around USD 1500, reaching fresh highs in recent days. Even more impressive is the rally in silver, which is now trading around USD 44. Silver has clearly been outperforming gold recently but I think the main story is that all precious metals are well supported.

In our last update, we said that in order for prices to move up further, we would need to see fresh news. The fundamental driver of precious metals is obviously the huge amount of liquidity created by central banks and the further ongoing monetization of debt, which will in turn hurt the value of paper currencies. But that has been going on for awhile and has been the main driver in recent years.

What is the real value of gold and silver? In my view, I think no one can answer that question, but it does not really matter. The value for gold and silver is what the market is willing to pay for it; so currently about USD 1500 for an ounce of gold and about USD 44 for an ounce of silver.

When looking at the chart of both commodities, one can certainly argue that this is a market that is in a bubble-building process currently and to some extent I would even agree with this. However, as long as you have more people wanting these metals, the current prices are not only well supported but have further upside potential.

In our last update, when gold was trading at around USD 1330/ounce, we said we expect more buying activity after the Chinese New Year. And in fact, we have seen increasing volumes since then. Not only from private investors but also from large buyers such as central banks, looking to increase their strategic holdings of gold. Remember, many central banks are currently looking to further diversify their reserve holdings and they are no longer willing to solely depend on the U.S. Dollar or the Euro as a reserve currency. We can expect that buying activity continues in the short-term. Also, you have more and more private investors chasing these precious metals trades; it seems like many people have become gold bugs.

The current discussions about precious metals reminds me a bit of the late 90’s when everybody became an expert in stocks, especially technology stocks. Many believed you could make a living just from trading these investments. Today, we all know how that hype ended. Many stocks are still trading far below their highs seen in the late 90’s or in early 2000. Also, many of these companies do not even exist anymore.

Don’t get me wrong, we keep our positive outlook for precious metals but we think every trend will eventually come to an end. We might have entered the last phase of the precious metals bull market and could see prices going up another 30% in the coming two years. But eventually we hear more and more people questioning the true value of metals, especially should we see much higher interest rate levels in coming years. (And that's a scenario that we regard as highly likely.)

Looking at the chart below, it clearly shows that silver has become the “trade of the day” and it seems to be very popular now “to be in silver”. We think that there are an awful lot of trend followers in this trade and we think the risks of a correction are rather big.

So what could initiate the next upward move in gold? We think that there are a number of catalysts in coming months, especially the ongoing debate about the U.S. debt limit and some additional negativity surrounding the U.S. and the U.S. Dollar. These could result in a Dollar crisis and would become the main market theme. In such an event, we think prices for precious metals could easily go up another 20%. The bottom line is that the upward trend for precious metals is still firmly in place, but it is wise to watch for signals that would indicate that the long-term bull market is in its late stage.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.