By Jordan Roy-Byrne
Normally we write about the things and conditions that cause precious metals to rise. While these things may be obvious, the corresponding rise in the bull market will not always be consistent and linear. Small and large corrections will occur along the way. Some will be purely technical while some have real drivers. There are three things which can precede a deep correction or consolidation in the precious metals complex.
Precious metals perform best when strongly outperforming most other markets. They are at times an “anti-investment.” In other words, when stocks and/or commodities are healthy, there is going to be less demand for precious metals. This doesn’t mean precious metals will decline, it just means they won’t rise or rise as much.
Remember, stocks performed especially well from 2003 to 2006. Precious metals still performed well but not as well as in 2001 to 2003 or in 2007. In early 2009, Gold (GLD) neared $1000 but stocks were set to begin a huge bounce, which evolved into a cyclical bull market. The first six months of said bounce caused Gold to consolidate before it would eventually break $1000.
Currently, stocks are performing well as are commodities led by energy. As a result, some investors feel they won’t need to invest in Gold if the “conventional” options are performing well. I expect this to continue in the early part of Q1 in 2011. This is partly why the precious metals complex is consolidating or correcting.
The biggest issue and driving force for the bull market in precious metals is the sovereign debt situation. Inflation results from excess money and credit growth while hyperinflation or severe inflation results from the inability to grow out of the debt burden. The latter is more tied to the economy.
It happens very quickly in small countries with small borrowing power. They accumulate too much debt, their economy weakens and as the economy fails to grow quickly, the market demands higher interest rates which eventually leads to default or printing money. Monetizing the debt (also known as printing money or quantitative easing) is one way to forestall the rising rates. This is what we are doing and what Europe and Japan have done. We can do it because we have a massively huge bond market compared to Greece, Argentina, Iceland, etc. For those who can’t figure out why Gold is rising or why this is a bull market, there is your hint.
If the economy would grow fast enough then debt to gdp would start to come down and the budget would come under control. This would lead to lower interest rates. Problem is, the US economy is growing well below trend in this “recovery.” Debt and interest service costs continue to grow faster. We would need to see above trend growth sustained for several years. If you believe this is reasonably possible or likely anytime soon, then I guess you believe pigs can fly.
Silver in 2004, 2006 and recently, provides the best examples. The market reached a level where it was well above the moving averages. There was little chance of the market avoiding a correction or consolidation. The same could be said of Gold in 2006 and Q2 of 2008.
Since late 2008, Gold has followed a different pattern. It has gained for three to four months then corrected for one or two. This action is far more sustainable then a vertical move for several quarters. However, silver has reached a technically overbought condition, so it will need to consolidate for at least several months. Gold is less vulnerable at present.
Conclusion
Presently, other markets are performing better and that is providing resistance against a rise to new highs in precious metals. Silver is also technically overbought. A consolidation is needed to digest the huge gains and bring the market back to more of an equilibrium.
Disclosure: No position
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