Precious Metals May Fall Short-Term, But Don't Be Fooled by the Pullback

Posted by Adam Sharp - Tuesday, May 17th, 2011

[update 5/18 - Silver may have bottomed around $35. Waiting for confirmation, but we may have found a floor.]

Silver is undergoing a rather nasty correction.

Yet it's still up more than 70% over last year, and 260% since late 2008 (chart below). Yesterday the metal fell 4.4%.

A V-shaped bullish reversal back toward all-time highs seems less likely, at least in the next few months.

Over the next year or so, though, I expect that silver will blow past those old highs. But it's very possible that we get a nice buying opportunity before then -- Prior to the unveiling of QE3, and acceptance of the fact by the market (late summer - late fall, possibly).

Jumbo QE?

QE3 is likely to be larger than QE2 (which was officially $600b, but more like $900b when you include reinvestments). An increase in the size of quantiative-easing programs would shock some folks. But it should be expected, really.

Printing money doesn't really make things better, after all. It kicks the can, inflates, bails out, spurs bad investments and loans, etc etc.

So round three will need to be pretty big to support the Feds' policies. Roughly $1 trillion will need to be printed to fund monetization of debt over the next year.

Debt monetization occurs when money is printed to cover government spending that is not paid for with taxes or debt. We've been doing it since QE2, as even Fed Governor Richard Fisher has admitted. Bernanke still hasn't come to terms yet, and likely never will.

Strong bull reversal in silver near-term is still possible, but less likely

One factor that could tilt the axis back in favor of bulls is lower silver margins in Shanghai, says Tyler of Zero Hedge.

Lower margin requirements make it cheaper for traders to hold a commodity. On the other hand, margin "hikes" make it more expensive. Margin changes affect underlying commodity prices in the short-term, at least on paper.

For example: the drop in silver from near $50 to the mid-$30s today coincided perfectly with the CME group's 5 consecutive margin increases in a week. They more than doubled the cost to trade silver, and caused a shakeup in the paper market.

Margin requirements do need to change sometimes, and increases can be a good thing. They restrain excess speculation.

But this was excessive, and had a whiff of desperation and possibly manipulation to it. Despite silver falling 5-10% per day after the first 2-3 bumps, they continued to hike on each successive day. Kick the horse till it stops neighing. Ruthless.

CME Group officials assure us there is no correlation between the hikes and the 27% correction, despite the fact that they occurred over the same 5 trading days. Pretty much everyone else blames CME margin hikes.

BUT -- eventually the CME may also come under pressure to lower margins, seeing how far silver has pulled back since. That would be bullish.

Nobody knows how it will play out. But margins are another factor that could shake things up.

Another possible trend-reverse catalyst is Asian buyers, who tend to appreciate hard money more than the average Westerner. If they step in en masse and start gobbling up metals on the dip, the bulls could be on parade again sooner than expected.

The long-term case for precious metal ownership is utterly intact, of course. But things are starting to move more quickly now, so we're experiencing more turbulence.

Silver - still up 73% over the past year

Let us not lose sight of the fact that silver is still up 70% + over the last 12 months. I distinctly remember being thrilled at the prospect of $25 silver last year. We've come a long way.

kitco silver chart

Silver is still trading at 3x 2008 pricess in US dollars. And it could be had for $5/ounce not all that long ago.

I prefer studying multi-year charts, not the 5-day ones anti-gold commentators must be looking at. If you're investing for years, look at longer-term charts. Spread purchases out over time.

Ultimately, only short-term traders should worry over short-term moves. It's no fun watching your favorite metal go down after a euphoric run. But, that's investing for you...

Gold still shining

Gold has done remarkably well over the last decade. Take a look at the performance of EKWAX, my favorite gold mutual fund. 27% annualized returns over the last 10 years. The S&P is essentially flat over the same time, and probably negative in real terms (when you adjust for inflation).

Palladium has still soared from sub-$200 just a few years back to over $700 today.

In short -- don't let this or any other pullback fool you. Re-examine the bull case, think about what the Fed is likely to do in the future (hint: print more), and make a decision.

If I still have any cash left (after paying for gas), I will be buying on the dips.

I suspect most gold haters have no position in metals -- long or short -- as most of the ones I've talked with don't seem to have done much research. And if they've been short over any extended period over the last 10 years, they're sitting on big losses.

Their cases usually come down to It's a bubble! bubble! bubble... bubb bub? What's the dollar have to do with this, anyway? We have a strong dollar policy, Geithner says.

QE2 ends, buying opps begin (guessing late summer to late fall)

QE2 ends June 30, mark your calendars. And remember that even short-sighted Wall St. analysts act a little bit ahead of the news.

Having a little cash on hand in advance of the end of the Fed's massive monetary adventure (round 2), may not be the worst idea in the world.

Though I don't like holding rapidly-depreciating dollars, sometimes it is necessary for we Americans. That said - I don't plan on selling physical PM holdings any time soon. Too much hassle, too hard to time in this crazy market. At least for a small guy like me.

Not to mention, I'm not overly eager to convert into fiat dollars, either.

If we get a 5-10% pullback, momo traders and hedge-funds will probably be forced to liquidate hot investments, as their clients start to freak out and pull their funds. Why did I own gold, anyway? It's down 5%. Sell!

Then -- when the fed announces the printing party is back on, and dons their QE3 party hats, breaks out the kazoos -- the move up will continue. That's the most likely outcome, as I see it.

If deflation is allowed to occur (meaning the Fed raises rates aggressively and stops printing), metals still offer decent protection. They'll fall in price, sure. But so will everything else. That'd be the economy trying to correct itself. But I strongly doubt it will be allowed to do so properly.

Lack of reaction to ME incidents

I was surprised that markets weren't roiled more by the recent unrest on Israel's border. Didn't get much exposure, and wasn't on any of the mainstream news sites' homepages that I checked around mid-day ET.

Donald Trump, of course, got top billing on all the big outlets.

Perhaps it was just a one-day event. We'll see. I covered the Nakba turmoil more here, with pics and video.

The fact that metals were down the day on the first trading day after a pretty big international incident on Israel's borders was surprising.

Gold and silver often pop on days like this, but that was definitely not the case today. Another reason a further correction seems likely. Not the worst thing in the world, and a buying opportunity if played correctly. We'll be watching the situation closely.

Stocks overall: weak

Overall, stocks dropped a bit today, but nothing too crazy. Nasdaq was dog de jour, down 1.27% compared with the broader S&P 500's loss of .62%.

Stock indexes are starting to falter, though.

A relatively mild and short bear market, lasting till the QE3 party hats come out, would not be a big surprise. Stocks could drop 10 or 20% in 6 months, I'd guess. Not saying it's going to happen, but things are looking a little toppy, to some.

Eventually the Federal Reserve liquidity brigade will come to our rescue after stocks dip, offering to make everyone's 401ks look better (on paper). Then -- Surprise: QE3! Rinse, inflate, repeat.

Adam Sharp
Editor, Wealth Wire



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