The Great Gold-Silver Divergence

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Includes: AGQ, BAR, DBS, DGL, DGLD, DGP, DGZ, DSLV, DULL, DZZ, GEUR, GHE, GHS, GLD, GLDI, GLDW, GLL, GTU, GYEN, IAU, OUNZ, PHYS, PSLV, QGLDX, SGOL, SHNY, SIVR, SLV, SLVO, UBG, UGL, UGLD, USLV, USV, ZSL
by: Ivan Martchev

In my experience, when precious metals are seeing strong investor interest, silver tends to outperform gold. This is because "poor man's gold," as silver is sometimes called, is a smaller market and therefore it is easier to move. The same dynamic works in reverse: When investors are not so hot on precious metals, silver declines faster than gold, so I am not surprised that silver is weak, now that the dollar is rallying, but I am surprised that gold is not weaker. This gold-silver divergence is also a bit of a head scratcher.

Gold Silver Divergence Chart

Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.

From a pure "chart" perspective, even though I am not much of a chartist (it has always been more important for me to understand the fundamentals that drive the charts), silver has made a series of lower highs and looks like its forming a "descending triangle" that's getting ready to break lower. The weird part is that gold has made a series of higher lows, even though it ran into resistance at its 2016 highs.

United States Dollar Index Chart

Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.

I think I have a good understanding of why the dollar is rallying and why it is likely to end the year over 100, as I have explained often in this column, but I cannot say I have a good understanding of why gold bullion is not much weaker by now. Could it be the Russians or the Chinese propping the gold price?

Russian and Chinese Gold Reserves Chart

Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.

First, let's look at the Russians, who have been very consistent buyers of gold bullion for self-defense purposes, as they are quite uncomfortable with quantitative easing and all the kinds of monetarist maneuvers being played by the Federal Reserve, the European Central Bank, the Bank of Japan, and the Bank of England. They are also uncomfortable with the bull market in Treasury issuance and debt issuance in general in the developed and developing world. (For more on this issue, see the November 20, 2017 Saint Louis Fed publication, "Global Debt Is Rising, Especially in Emerging Economies.")

United States Government Debt Chart

Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.

While I agree that the Russians have been very cunning when it comes to their military operations and foreign policy, one place where they have been completely frank is their disdain for monetarist operations in the developed world. They have decided to put a large part of their financial resources in gold bullion.

Russian Budget Situation Chart

Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.

This aggressive Russian buying of gold bullion comes at a time when their government budget situation is stabilizing and their foreign exchange reserves are climbing courtesy of the rebound in price of their biggest export, crude oil. Russian President Vladimir Putin, love him or hate him, knows how to run a tight fiscal ship and has brought economic order, which is why he gets such a high approval rating.

Putin Approval Rating Chart

Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.

The Mainland Midas Effect

The Chinese also have been consistent buyers of gold bullion, but their reporting is significantly inferior to anything one sees from the developed world, or even Russia. I would take a Russian economic release with a much higher degree of confidence over a Chinese one as the mainland bureaucrats are notorious doctors of GDP statistics. For instance, Chinese economic statistics did not show a recession in the early 1990s, yet mainland bank loan-loss ratios showed evidence consistent with a bad recession that forced the People's Bank of China to devalue the yuan to the tune of 34% in December 1993; so when it comes to the PBOC telling the world how much gold they have - or how the Chinese economy is doing for that matter - I don't quite take their numbers with a solid-gold guarantee.

It's a definite possibility that China could be buying more gold bullion than they are reporting. Their foreign exchange reserves have started to go down again, which is rather peculiar as their trade surplus with the U.S. is headed for another record in 2018, so the supply of dollars in China should be plentiful.

Chinese Yuan versus China Foreign Exchange Reserves Chart

Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.

I am keenly aware that the recent decline in Chinese foreign exchange reserves may be due to the resuming capital outflows, courtesy of their busted credit bubble, which should result in a hard landing similar to the one experienced in the Asian Crisis in 1997-1998. Or, we could see capital outflows and more Chinese gold buying at the same time as only they have a good idea how bad the situation in their financial system truly is. I suspect it is quite a bit worse than they are letting the world know.

Whatever the reason for the mysterious bid in the gold market at present, I don't think that it will last, given how far the dollar is likely to rally in 2018 and 2019. Not even the giant Presidential egos of Vladimir Putin and Xi Jinping will be able to keep the gold price from breaking $1000/oz. if the dollar experiences a giant synthetic short squeeze courtesy of the explosive effects of the rampant global dollar borrowing in the past 10 years, catalyzed by 2018's accelerating Federal Reserve quantitative tightening.

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