Thursday, September 14, 2006

Gold and silver slump irrational

To say that gold and silver have taken a beating the last week or two is an understatement. Further, I can't from any reasonable stand point understand why they have fallen so far so fast.

Both South Africa and Australia have posted lower year to year Gold production, South Africa, the worlds largest producer has been following a downward production trend for 5 years. This trend is world wide as more and more of the old, easy and cheap mines are exhausted and are replaced by smaller, poorer grade and harder to mine deposits. At the same time energy which is a major component in mining costs is rising drastically. The third component to the supply side is the political/labour instability and nationalism in many producing countries. The trend in many developing countries is to change the laws and void contracts in a bid to take a larger share of mining profits for the host countries, miners are also demanding a larger share of the pie and labour disputes are becoming more frequent. Silver while showing some growth in production is matched by new industrial uses and a renewed interest in silver as an investment. All of these facts should be supporting the price if not giving it strength.

The claim is that the Gold fell on U.S. dollar strength, this sounds awfully convenient especially when there is no logical reason the U.S. dollar would gain in value.
1. the U.S. is still creating money at a breakneck pace adding just short of 5 billion dollars to the money supply last week.
2.. Consumer debt levels are still climbing, 2005 disposable income rose 1.2% while personal debt rose 11.7
3. U.S deficit spending is not slowing
4. Housing collapse, estimates range from a 5-40% housing market correction, losses already taken in Florida make the 5% look ridiculously optimistic.
5. Ford and GM are on the brink of insolvency and could destroy 300 billion + of investor value.
6. Misreporting of inflation is being noticed and some estimates such as those at International Forcaster put it over 10%

All these facts are disturbing and mean a great deal of pain for the average citizen and doubly so for investors. It is unclear at this point how this will play out but both hyper inflation and deflation can be argued for. It is also possible that a wave of one could be followed by a wave of the other and as bad as inflation and deflation could be there is even a more devastating possibility on the horizon that of a total monetary crisis.

The devaluation over the last few years of the U.S. dollar is a warning sign of a possible implosion of the dollar. Each day billions of dollars are borrowed to float the current government debt and the continuing deficit spending. Each time the dollar weakens in value it becomes that much harder for new debt to be sold and that much more likely that countries already heavily invested in U.S. debt will attempt to sell their debt in an attempt to cut their loses. If the debt cannot sold externally the only option for the Fed is too create money and internalize the debt. This creation of money will put further downward pressure on the value of the dollar creating a virtual currency death spiral, much like Argentina in the 90s

So why has silver and gold been hit so hard recently?

There are several possibilities that immediately rear their heads some simply technical others pure manipulation.

1. The market was over sold. Many who do not believe that gold and silver have any special value beyond it's rarity as a commodity will say that the commodity run is complete and gold and silver will fall in value like all other metals, oil, houses. If most investors don't credit these metals as monetary metals but rather a simple commodity than this is reasonable. These investors are convinced in the long term survivability of fiat currencies and are most likely very wrong. History shows paper currency is not real money and eventually fails.

2. Simple profit taking by hedge funds and institutional investors. These groups buy for the trade and jump in and out of investments when they have made their targeted margin often at the whim of automated trading programs. These investors are not interested in long term retention of wealth but rather the creation of false paper wealth.

3. Manipulation of futures. Both gold and silver have huge concentrated short positions that have undo control of the market pricing. When you can sell huge quantities of a commodity you don't actually own it's very easy to drive the prices down. Despite this control, fundamentals have allowed the creation of newer and higher support levels for gold and silver over the last several years. I have no doubt that in the long term this trend will continue.

4. Government sales. For those who believe (rightly so) that gold and silver have monetary value and not just it's use in industry and for trinkets, these metals show an important reflection of money's true value. As paper currency devalues people will turn to real assets to protect their wealth. Gold and silver have a long and honoured history as real money, which can't be forged, arbitrarily created. The government knows this and when metals look too strong , it makes paper look to weak. To counter this Central banks flood the market with bullion driving the prices down, simple supply and demand.

All this does nothing to change the fact the the U.S. dollar is in real danger of imploding, but for the time being it does lessen the perception that the U.S. dollar is in danger. With elections approaching in Nov there is no chance the government will allow the dollar to slide, interest to rise or the true value of the government debt to be accounted.

This current "correction" is perhaps the last chance to get a bargain in gold and silver. Should there be a melt down of the dollar, money will flood into the precious metals market as people try to protect what value is left in their currency. This influx of cash will raise the value of gold and especially silver due to it's tighter supply issues. Gold and silver are monetary metals despite nay sayers, these metals have survived with real value through out the ages and in an enviroment like todays when bad paper is becoming more prevalent it is perhaps the only safe haven for your wealth.

4 comments:

Ted said...

isn't likely that the government will just seize gold and outlaw private ownership of metals?

Lord of Wealth said...

Unlike in America, Canadians did not have their bullion siezed by the government. In fact many smart or daring U.S. citizens moved their gold to Canada either ahead of the seizures, knowing something was up, or smuggled it to Canada after the ownership ban. Others just hid or burried it. Up until the change of laws, smuggling of gold coins like the Krugerand was still going on with a large portion of such coins making their way into American stashes.
Never say never but the U.S. regime seems to have little use for rights at this time and I certainly think there is less chance of confiscation in Canada

Anonymous said...

The current correction may be tested as is referenced in a recent article on 321gold.com. To relate the contents on the item in brief, if gold rallies back over $600US, the interm rally could carry it up a little way. Then the next leg of the correction could begin. Long term, the position is still bullish. Of course, the situation in Iran could escalate shortly too... if it does, the sky is the limit...

Lord of Wealth said...

The war bonus is something I realize but don't bank on. I think finacial fundamentals suck enough to justify metals on their own merit.
That said, further foreign invovement = more spending, more inflation, more chance of a major fiscal cirsis and the posibility that some U.S. debt holder will us debt instruments as a weapon. A flood of resale U.S. debt could easily start a major slide for the dollar as the rats flee the ship. Any or all of the above will speed up the rise of metals and the death of the Greenback.

Personaly I look forward to the day 1000 oz of silver or 10 oz of gold will buy me a 500 acre Montana retirement ranch.