Fall officially began on September 21, but it's not just leaves that are cascading downward. In the few market days of the new season, precious metals prices have seen significant drops, some 11% for gold and 31% for silver. In its lurch downward, gold plowed through support levels at $1,750, $1,700, and $1,645 an ounce. I'm sure many readers are concerned.
After all, by the time gold put in its recent peak on August 22, it had logged a stunning 44% appreciation in calendar year 2011. And even after its recent tumble, the metal is still 22% higher than it was on January 27, the 2011 low. Therefore, some may conclude that gold has further to fall, and that the descent could be steep.
Given this anxiety, it might be helpful to summarize some factors we see impacting prices. Emotions loom large in the financial world, and it is easy to lose one's focus during periods of uncertainty. From as rational a perspective as I can gain during these irrational times, here is my view on why precious metals have recently pulled back so violently:
Market Technicals. Given the swift rise of gold and silver during the first half of 2011, precious metals were due for a correction - especially following the parabolic increases that we saw in August. Markets never go up in a straight line, and often the biggest downward movements occur in bull markets. These sharp movements are common in gold, especially during short periods of financial panic. For instance, gold fell more than 25% in the second half of 2008, and almost 15% from February to April 2009. Yet after the dust settled in those earlier corrections, gold resumed its upward march with even more gusto.
The progressive rise in margin requirements is another technical factor that has weighed on gold and silver. In recent months, many of the exchanges that offer margin accounts for metals futures contracts have made it significantly more expensive to hold those positions to maturity. This has caused many forced liquidations, putting downward pressure on prices. Many have even speculated that that these dramatic changes in margin requirements were deliberately planned to undermine confidence in gold as a safe haven asset.
Recession Risk. Recently, it has become clearer to more people that the economy is not recovering. Just last week, Fed Chairman Bernanke offered his most gloomy economic outlook since 2009. Many people recognize however that the Fed Chairman is sugar coating the truth and that the real economy is actually even worse. Some believe we are headed for a full-blown depression. In such conditions, liquid cash becomes king and, typically, commodities fall. In this respect, silver, which has more industrial use than gold, can be expected to fall faster in the short term.
But even gold can be expected to fall under these circumstances, especially if official inflation reports stay relatively calm. Unfortunately, what the markets have yet to grasp is that this time, recession will likely be accompanied by high inflation and a risk of currency collapse. To investors who understand this logic, precious metals are still highly attractive.
Liquidations. It has been rumored that some major investors, including hedge funds, have liquidated large precious-metal positions in recent weeks. Many of these investors were likely sitting on large gains in gold & silver, but with the broader equities markets taking a tumble, they may have decided to lock in profits to offset losses in other positions.
Recently, as political and banking problems have loomed larger, liquidity has become a primary factor in determining investment decisions. In other words, big investors are just trying to cover their debts instead of investing for the long term.
The Greek Bailout Plan. Many investors seem to have placed great hope in the recently announced Greek bailout plan to solve the sovereign debt crisis, driving down their appetite for gold as a long-term safe haven. This is overly optimistic. An orderly Greek default is not in our future. The German plan is a poor imitation of the Fed's "extend and pretend" policy that was the basis of TARP, also known as the bank bailouts. It is likely that when markets perceive the gaping holes in the plan, fears of a currency crisis will return, and gold will benefit accordingly.
US Dollar Strength. As it has so often in the past, the US dollar has gained strength in the early days of an economic slowdown. This has put downward pressure on the price of precious metals. We believe that dollar strength is a temporary phenomenon, for reasons with which our readers are quite familiar.
Central Bank Intervention. Central bankers have long been embarrassed by the price of gold, which exposes their surreptitious currency debasement. For many years, the central banks of major debtor countries have sought, via IMF intervention under Central Bank Gold Agreements I and II, to magnify any natural market volatility in order to dispel the perception that precious metals can be a superior store of wealth. Although the central banks of surplus nations are accumulating gold, it is possible that the IMF is acting still to magnify any market price volatility.
While some or all of the above factors may have contributed to the recent fall in precious metals prices, investors continue to face the prospect of a currency crisis that will cause gold & silver to soar. Even at $1,600 an ounce, gold is still only at some 64 percent of its all-time 1980 inflation-adjusted high. Readers should consider these factors before selling their holdings of precious metals and capitulating to the eradication of their wealth by central banks.
Only time will tell how far precious metals will fall. But if we are correct and gold reaches into the many thousands of dollars per ounce, our future selves will care little whether we bought at the absolute bottom. We will just take comfort in having bought.
Subscribe to Euro Pacific's Weekly Digest: Receive all commentaries by John Browne, Peter Schiff, and other Euro Pacific commentators delivered to your inbox every Monday.
Click here to learn more about Euro Pacific's gold & silver investment options.
For a great primer on economics, be sure to pick up a copy of Peter Schiff's hit economic parable, How an Economy Grows and Why It Crashes