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Adam Hamilton

Adam Hamilton

Mr. Hamilton, a private investor and contrarian analyst, publishes Zeal Intelligence, an in-depth monthly strategic and tactical analysis of markets, geopolitics, economics, finance, and investing…

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Gold and Silver Update

Even in our increasingly digital and ethereal world dominating the young Information Age, the timeless allure and value of physical commodities with real mass and volume have not been vanquished. Slumbering deep in the hearts of men, waiting to be rekindled, lie the ancient passions of boundless gold-lust and silver-lust. Both a blessing and a curse, these classic human emotions of adoration and greed for the fabled yellow and white metals could explode into mainstream investor consciousness yet again at any moment in time.

Even while the investing masses continue to futilely chase the last dying bubbles, the great equity manias of the late 1990s, new foundations for awesome new bull markets are stealthily being laid. Unfortunately for most investors today who are utterly blinded by the myopic perspective of day-to-day and quarter-to-quarter market noise, the early emergence of these great trends that will totally alter the investment landscape in the next decade will initially be widely overlooked.

As I wrote last April in my essay "The Great Commodities Bull of the 00's", for many reasons my partners and I believe that the once loved but now loathed commodities arena commands the highest probability of being the next great magnet for speculative excess in the first decade of our shiny new millennium.

At this peculiar moment in history when the popular love for the dying equity bubbles remains enormous, uttering such heresies is still considered the height of lunacy by most investors. Yet, just like all successful contrarian investors of the past and the present, we strive to learn and apply the secrets of investing that have been tremendously successful for centuries, not just the narrow primary-equity-bull-market strategies that proved so successful in the 1990s. The mighty equity bubbles of recent years were great fun before they began imploding, but now it is time to gaze further out to the horizon to attempt to discern the epicenters of the next potential speculative manias.

Lately, with so incredibly much at stake for the tens of millions of investors still trapped deep inside the battle-scarred skeletons of the fading equity bubbles, we have largely focused our Internet essay research efforts on the equity markets. It is really heart-wrenching to watch so many hard-working investors, after having scraped and saved their entire lives to amass small fortunes, be lined up like sacrificial lambs for the slaughter by Wall Street in this current great Bear Market Rally. The poor folks who lost their life savings in the Enron debacle were just the beginning. We sincerely hope, perhaps naïvely, that our humble essays could perhaps reach even a few investors out there who still have time to protect their scarce and valuable capital before the next major down-leg in the equity markets commences.

Yet, even when ranting and raving about rampant equity-market extreme overvaluation and the hyper-dangers of buying into dying bubbles, my partners and I continue to grow ever more convinced that a commodities boom is brewing. We have published many past essays chock-full of background information that are available on the Commodities page of our website and we continue to discuss various promising commodities arenas monthly in our private newsletter, Zeal Intelligence. We have even been blessed with many excellent early equity-commodities plays, achieving double-digit gains in gold, silver, and oil stocks we own and have recommended to our clients.

Rather than reiterate the exciting background information that is laying the fundamental foundations for large gains in commodities themselves and enormous gains in stocks that produce key commodities, I would like to simply offer some brief thoughts on the gold and silver markets this week. Both of these key commodities arenas are looking increasingly interesting and it is really important that contrarians keep an eye on the horizon watching for early signs heralding the coming commodities boom.

As gold is the undisputed Ancient Metal of Kings, we will start with the fabled yellow metal. Then we will move on to silver, a terribly under-estimated commodity that could easily witness the largest raw percentage gains out of all the major commodities in a new commodity bull market.

Just like the equity markets, fundamentals also ultimately drive the commodities markets. For stocks all that really matters over the long-run is corporate earnings. If earnings rise over the long-run then stock prices rise too. If earnings fall over the long-run, stock prices will inevitably follow. Corporate earnings are the ultimate core fundamental attribute driving stock prices over the long-term.

In commodities, the ultimate core fundamental attribute driving long-term prices is supply and demand. If the demand for a particular commodity is greater than the supply, its price will be bid-up in the free markets until equilibrium is reached and the market "clears" with demand perfectly equaling supply. If the supply of a particular commodity is greater than the demand, its price will be sold-off enough to kick-up demand and reduce supply so the twain meet comfortably at a middle equilibrium point.

The macro-forces of supply and demand ultimately moving market prices are certainly not rocket science, but core supply/demand fundamentals are very important to keep in mind for prudent investors. Long-term investors are only successful when they let fundamentals drive their major buy and sell decisions, not fleeting emotions!

The global gold market is so incredibly appealing because far more gold is being purchased each year around the world than is being mined annually from the dark entrails of the earth. In addition to mined supply, however, currently central banks are selling huge hoards of gold they have accumulated over centuries at fire-sale prices. This additional marginal supply above and beyond mined gold is enough to meet enormous world-wide demand at current low gold prices today, but more and more evidence is surfacing suggesting that the central banks are both running out of gold to sell or lease and losing their will to embark on such ultimately destructive and futile campaigns.

The day central banks stop flooding the markets with dishoarded gold, a huge global supply and demand gap will be instantly ripped opened. As it takes many years to both find new gold deposits and then jump through innumerable flaming hoops to plant mines on the promising sites, once the wanton central bank selling abates global gold demand will vastly exceed available mined supply each year. Huge demand plus dwindling supplies equals a major gold rally barreling down the pike.

The prospects of gold as an investment are stellar not because it is the ultimate asset throughout history, not because the general equity markets are struggling, and not because of future fears of a systemic market failure. Gold is appealing because it is very hard to find, very valuable, and most importantly because not enough of the heavy yellow metal can be dug-up around the world each year to meet growing global demand unless gold prices rocket far higher, almost certainly over 100% above current levels.

Even though gold continues to apparently limp along in despair far under the Western World's investors' radars, recent price action is very promising. The following graph shows the daily closes in gold since 2001 began, a little over a year of data. Also graphed is the Philadelphia Stock Exchange Gold and Silver Index, the XAU, which we view as a kind of rudimentary proxy on gold investor sentiment. Rough technical trend channels for both gold and the XAU are outlined below with the dotted arrows.

Gold and the XAU

For the legions of shell-shocked gold investors, who recently have often felt like Afghan guerillas being bombed relentlessly with enormous Daisy Cutter conventional bombs, it may be hard to believe, but gold remains firmly entrenched in an unmistakable uptrend. The yellow dotted-lines above mark the general one-year trend for gold. The lower support line has not yet been significantly violated.

Since its dismal lows in April 2001 around $257, gold has stealthily rallied over 12%. In a year when the S&P 500 plunged a painful 13%, a 12% rally in gold is nothing to be scoffed at. The vast majority of great rallies in history begin with modest and easily-overlooked uptrends that eventually blossom into something much more spectacular as they evolve.

Gold has already broken through the upper resistance line shown in the graph twice, both in the awesome mid-May gold rally (see "Gold Prepares to Erupt") and the big post-September 11th gold rally. Unfortunately tremendous gold selling activity, much of it of the naked-short persuasion in the futures markets by the usual suspects, effectively capped the exciting May 2001 rally in gold. The post-terrorist-attacks rally eventually collapsed as well, also under heavy selling bombardment, as investors realized that the US equity markets would not burn into the ground in the violent wake of the tremendous nonlinear discontinuity of the terrorist strikes.

Interestingly, at this moment in time gold is once again trading near the top resistance line of its primary trend channel. Will gold finally break free and challenge the Maginot Line that the gold shorts have drawn in the sand at $300? As a mere mortal who cannot see the future I have no idea what surprises the near-term may hold, but I do know based on endless historical research that the gold price always does ultimately respond to supply and demand fundamentals and that any entity that seeks to artificially force gold to trade outside of what fundamentals dictate inevitably totally fails.

Sooner or later, unless some yet unknown gargantuan new gold supply suddenly comes online, gold prices will be forced to rise by titanic market forces in order to restrict enough demand and entice-out enough new supply so the gold market can once again trade in balanced equilibrium, at prices far higher than today's. The distinctive uptrend in gold over the last year cannot yet be dismissed as just another false rally. It certainly may be, but it could also prove to be the modest beginnings of something much bigger and more spectacular.

When viewed through the lens of the most popular gold and silver mining index (the XAU is actually comprised almost entirely of gold mining companies) the gold picture grows even more interesting. The XAU's gyrations can be monitored as a rough proxy for general gold investor sentiment.

Theoretically, before the gold market itself moves, someone somewhere should know about it. They may have insider connections with central bankers and know when the central banks are running out of gold to sell. They may be gold dealers in India who can spot important demand trends before the general markets. They may be gold-mine or mint managers who are watching the number of inquiries to their entity that are seeking large private gold purchases grow in frequency. Typically, before the markets make a material move someone out in this big world of ours should know (or at least be able to high-probability anticipate) that such a move is imminent.

Note in the graph above that both leading up to the May gold spike and the current gold mini-rally that significant XAU buying occurred well before gold made its largest daily moves, and that once gold did actually move the XAU buying exploded northward. This comparison, of course, failed in the post-September 11th rally as the spectacular terrorist strikes were not anticipated by normal market players. The current XAU rally from below the bottom of the trend channel to near the top is very similar to what we observed in May before the exciting May gold spike. The current comparison is certainly provocative, to say the least!

If one knew that a move in the gold price was coming, or suspected that such a move was imminent, one potential play to maximize profits would be to buy gold stocks if one expected gold to rise or sell gold stocks if one expected gold to fall. Quality unhedged gold mines can have tremendous leverage to the price of gold.

For example, while gold was up only 2% in calendar 2001, our favorite gold mine, South Africa's Durban Roodepoort Deep, roared up over 110% on the year. Our Zeal Intelligence clients realized a 59% gain during the year on our first recommended short-term Durban trade and currently have a 77% unrealized gain since early September in a second Durban trade (as of January 16th). Not too shabby for a bear market in stocks and what is still widely believed to be a bear market in gold!

The blue XAU in the graph above is also in a very significant uptrend in the last year or so, suggesting that more and more investors around the world are anticipating an imminent rise in the price of gold. We are not the only ones deploying speculative capital in the gold markets!

As quality gold stocks are positively leveraged to gold prices, one would expect that gold stock prices would rise faster than the price of gold. From its early April low of 46.21, the XAU has rocketed up over 30% (almost three times as far as gold), a spectacular sector gain especially in the midst of a vicious bear-market siege.

So far the XAU has been unable to decisively break free from its one-year trend channel. Yet, with the index now nearing its top resistance line, it appears that another trading battle is about to commence in the low 60's. If a breakout actually transpires and becomes a reality, it will no doubt prove to be a bullish omen for gold stocks as more technically-minded gold investors grow excited about the action and pile-in to ride the break above the trend.

Gold, the XAU, and quality unhedged gold stocks bear close watching in coming weeks!

While the fundamental case for gold is very bullish, it pales in comparison with the dazzling prospects for silver, the other monetary metal of history. Unlike gold, there are no known giant above-ground hoards of silver still existing on the planet which can overhang the market and dampen investor sentiment. Silver is much more of an industrial commodity in high demand today than gold, it is not subject to the fickle whims of central bank selling, and silver has experienced violent price explosions in the past.

In bubble terms, if you think of gold as the potential speculative equivalent of the "technology stocks" of the commodities world, very sexy and perpetually sought after throughout history, silver can be viewed as the "dot-com stocks" before their mighty bubble. If the past is any indication of the future, and it usually is, the absolute percentage gains in silver, for a lot of reasons, may utterly dwarf every other major commodity on the planet in a new primary bull market in commodities. When speculative capital begins chasing silver in earnest, an exceedingly tiny market, watch out above!

I haven't written an essay on silver in quite awhile, since September 2000, but we are always monitoring silver at Zeal. In my earlier silver essay "Lagrimas de la Luna" (the Spanish Conquistadors' version of the ancient Incan name for silver, "Tears of the Moon") I outlined the mega-bullish fundamentals for silver, which remain rock-solid and have grown even stronger in the intervening time.

As silver is somewhat of an obscure market because it is very small, has low information flows, and is challenging to analyze, I strongly encourage you to read-up on true experts' work on silver. Among the dedicated silver analysts for which I have great respect and admiration are Ted Butler of Butler Research and David Morgan of Silver-Investor.com. These two gentlemen seem to eat, breath, and sleep silver and have far more knowledge on the fascinating white metal than folks like me who have been attempting to analyze broader markets. If you are already a silver investor or considering taking the plunge, I strongly encourage you to study the excellent writings of Mr. Butler and Mr. Morgan, which will no doubt help create great fortunes for silver investors in the coming commodities boom.

While silver did not sail through 2001 in an uptrend as did gold, its graph is still very interesting. In addition to the silver daily closing data below, we used a single silver stock as a very crude proxy for silver investor sentiment since there is not a popular major exclusively-silver index to follow. We chose Silver Standard Resources, a small hyper-leveraged silver stock that we currently own and have recommended to our clients. We were blessed with the good fortune of buying Silver Standard stock (SSRI-NASDAQ) in early September before the attacks at the same time we recommended it to our Zeal Intelligence private newsletter clients. As we put our chips on the table at $1.60, we are sitting on attractive 66% unrealized gains in the stock as I write this essay (January 16th data).

A full discussion on Silver Standard is well beyond the scope of this essay, but it always seems to be the very nexus of silver equity speculation. It is a small lightly-capitalized stock and there is not enough room in it for many institutions to play, but private silver-equity investors seem to continually gravitate towards SSRI as their interest-level in silver as an investment rises.

Silver and SSRI

Silver has languished in an ugly downtrend for the last year or so, as is evident in its primary trend channel above. There have been a few significant breakouts but they have all soon collapsed back under the overhead resistance line not long after the initial breakouts. The May silver rally in sympathy with the May gold rally tumbled back down into the channel very rapidly. The post-September 11th rally lasted a little longer but eventually succumbed to the primary silver bear trend. The current rally, even though it is fading down as I write this, is still very impressive and remains far above the primary downtrend resistance line.

Unless this current silver rally fizzles and silver once again trades under $4.25 as it did both before and later after the 9/11 attacks, the silver market should be monitored closely by investors. Silver lease rates have been high for a couple of months, indicating that sufficient physical silver is not available for borrowing except at very high rates. In the past, high lease rates have indicated supply shortages and have been fairly reliable precursors to significant silver rallies.

Silver has definitely already rallied nicely since it flirted with $4 in late November, up 19% from trough to peak. But, in the context of silver history, a 19% rally is utterly trivial. Once silver gets moving, it really runs! The great question today is whether this current rally has run out of steam yet or not. Once again, no mere mortal can divine the short-term silver future, but evidence continues to suggest that fundamentals for silver are still extraordinary which lends much weight to the continuing silver rally thesis.

Much more silver is demanded each year than is mined, silver lease rates are still exceptionally high, large industrial users of silver absolutely have to buy the metal for certain critical applications (almost at any cost), and the silver mining industry has been so utterly decimated in the great silver bear market that it will take many years to once again ramp-up silver production in response to much higher silver prices. As long as these elements are in place, silver needs to be carefully monitored by investors as its volatility gradually grows more violent.

Many quality silver stocks, like Silver Standard shown in the graph above in red, are already in primary uptrends. SSRI could retrace a lot of its amazing recent gains and still trade well above its trend channel, a good omen indicating that silver equity-investors are growing ever more excited about silver's near-term prospects. As long as silver and silver stocks trade above their trend channels, every significant rally in silver must be taken seriously and viewed as a potential precursor to a major move. As long as investors prudently deploy protective stop-losses as prices rise and abide by the stops as prices fall, great profits can be won by trading the rallies and patiently waiting for the long-prophesied Big One in silver.

Net net, looking at both the current technicals and long-term fundamentals, gold and silver as well as quality unhedged gold and silver stocks could potentially yield impressive gains in 2002.

Both metals have very bullish fundamentals, large unsustainable global structural supply and demand deficits, and increasingly positive trading action. Since these ancient and proud precious metals are still almost universally loathed by the diehard mainstream investors today, there are still plenty of opportunities remaining for prudent contrarian investors and speculators to stake a claim in the next great gold and silver rush before the rest of the world realizes what is happening.

Quality unhedged gold and silver mining companies' stocks can be a great way to enhance leverage to moves in underlying gold and silver prices. Because mining costs are relatively fixed regardless of the prices gold and silver are fetching in the global markets, most of any increase in the metals' prices can flow right into the bottom line profits of unhedged producers blessedly free from crushing derivatives contracts. While much more risky than buying the physical metals bullions themselves, investing in key primary-metals-producing equities can potentially yield breathtaking gains.

Any way investors and speculators choose to play these two precious metals on the long side, either by buying the physical metals themselves (this strategy, by the way, is the safest and causes the most pain for metals shorts and will hasten the arrival date of the really big rallies), buying quality unhedged metals miners' stocks, or making highly-speculative bets in the futures and options derivatives arenas, the odds are that we are just starting to witness the very humble beginnings of major gold and silver rallies.

As contrarian investors we all need to strive to buy low and sell high. With gold and silver as unpopular today among mainstream investors as Osama bin Laden in New York City, there is little doubt that opportunities still abound to buy low. As the gold and silver rallies gather steam in the coming years, more and more investors will realize what is happening and metals prices will eventually soar to the heavens in a breathtaking speculative mania late in this decade similar to the late 1970s.

When you turn on the morning financial news as the commodities neo-mania rages in the future, and all you hear about are gold, silver, and other commodities, then the time to sell high is drawing nigh!

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