Fear And Loathing In Precious Metals
Dec. 22, 2014 6:13 AM ET
Summary
- Bulls and bears - fear and greed.
- Deflation loathes industrial precious metals.
- Bipolar metals.
- A down year in gold?
- "A word to the wise is infuriating."
However, each time I think I have figured out the next move for the precious metals, I learn that trying to understand these markets is virtually impossible. After that bullish article was published, precious metal prices moved lower.
Bulls and bears - fear and greed
Fear and greed drives all markets to some degree. Gold and silver are no exception. I have been trying to figure out, or at least explain, why these metals do what they do since I started trading them in 1983. I had a great vantage point, better than most. I ran one of the largest trading desks for an international bullion dealer and member of the London Bullion Market Association. I bought and sold gold with Central Banks and Supranational institutions around the globe. I even took some of the biggest precious metals positions in history, but I still find it difficult to explain why these metals do what they do. The best answer as to why the price of anything goes up is that there are more buyers than sellers and vice versa. It is the "wisdom of crowds" principle, and the market price is always the correct price at any moment in time.
Throughout history, precious metals have been a means of exchange -a currency. In modern times, they are barometers of fear. They go to levels where investors and speculators get greedy, and then they reverse. In recent weeks, they have been quiet. It is hard to figure in a world dominated by headline news that is less than settling why these metals have not reacted.
One thing that I have learned is that there are two camps in the world of precious metals. The camps are analogous to hard-core right-wing conservatives and left-wing liberals in US politics.
So dug in are their positions according to their ideology that they explain every event and every circumstance, spinning it with ideological vigor. Gold bulls point to easy monetary policies, they explain down moves as manipulation. Bears point to these metals as barbarous relics of a day-long past. Both camps make excellent arguments. The question becomes, what events trigger the crowd, the addressable market of investment professionals, speculators and individuals to adopt their point of view? Additionally, once adopted how long does it last?
As the year 2014 draws to a close I believe that both camps, precious metals bull and bears (particularly in gold), lost money this year. After riding a bull market that took gold from under $300 an ounce in 2001 to the highs of over $1900 in 2011, it is easy to understand why.
Those who stuck with gold in 2008 when it dropped from the then all-time highs, of over $1030 to under $700 were handsomely rewarded as the rally continued reaching even greater heights.
The same is true for silver. For those who are still long and lost money this year, it is greed - even though they may hold the same opinion as to the value of the metals, the fact is that these commodities moved lower in dollar terms in 2014 and they have lost value. For those who trade gold and silver on occasions, higher equity prices, a stronger dollar and the prospect of higher interest rates have not created the aura of fear necessary to bring them back to gold and silver.
Deflation loathes industrial precious metals
Commodity prices have dropped in 2014. With few exceptions, the asset class has suffered loss of value. Grains plunged as good weather created bumper crops, sending prices to the lowest level in years. The price of what is probably the most political and ubiquitously traded commodity, crude oil, has almost halved over the past six months. Iron ore, coal, copper and many other commodity prices have gone south. There is a host of reasons. Economic weakness in Europe, sluggish growth in China and a dollar that has rallied have been negative factors for commodity prices.
The current perceived strength in the US economy will eventually lead to higher interest rates. Gold and silver (as well as other commodities) trade in dollars, thus higher interest rates raise the cost of carry - a negative factor. The world has become a smaller place due to technology; what happens in other countries affects the US economy. Given the current state of affairs around the globe, the potential for contagion is a negative factor. All of this adds up to a deflationary scenario, and commodity price action in 2014 reflects those fears.
The prices of platinum and palladium are excellent examples of the fear of deflation that now permeates markets. Both markets are in deficit. The vast majority of palladium production comes from Russia, as a byproduct of nickel in Siberia. Palladium prices are higher on the year only due to the current issues surrounding Russia and Mr. Putin. Platinum prices are lower on the year. This is after a five-month strike at platinum mines in South Africa, the country that produces the lion's share of world supplies. The price of platinum is at or below production cost for many South African producers.
Fears of deflation explain lower commodity prices. When it comes to precious metals, investment demand is always what drives price. Given prospects for deflation, investment demand is just not at levels that will support higher prices, at least for now. Investors are loathing commodities and precious metals.
Bipolar metals
I believe that when it comes to understanding commodity prices, the nominal price you see on the screen is a one-dimensional picture. In order to establish true value, one must look at other substitutable commodities to understand historical value. Historical value is important because history tends to repeat itself. Patterns are not always the same, sometimes they bend a bit but we can glean a tremendous amount in terms of value from this discipline.
In 2014, we have seen a huge divergence from historical norms when it comes to precious metals. It has been a bipolar year for this sector of the commodity market. Over the past forty years, the price of platinum has traded as low as a $200 discount to gold - that was in the wake of the financial crisis in 2008 and during a global recession. Prior to the downturn, platinum traded to a high of over a $1,100 premium to its yellow cousin. Platinum is ten times as rare as gold and it has a host of industrial applications. As I write this piece, platinum and gold are trading at the same exact price. Given historical price action, this leads me to believe that currently either platinum is too cheap or gold is too expensive.
The other bipolar relationship is that between silver and gold. Silver prices moved lower in 2014. At the beginning of the year, there were around 61 ounces of silver value in each ounce of gold value. This is the silver-gold ratio. Over the past forty years, the average for this relationship was 55:1. Over the course of this year, the relationship has extended to where it currently is around 75:1. As in platinum, given the historical trading pattern, either silver is too cheap or gold is too expensive given current price levels.
Given action in the precious metals sector in 2014, bipolar trading levels currently exist.
A down year in gold?
While gold is currently expensive relative to platinum and silver, it is still lower than it was at the beginning of the year. As of the close on Friday, December 19, gold is down around 3.6% on the year, in dollar terms. Therefore, it is not that the gold price has been so strong, rather that the prices of its precious cousins, silver and platinum, are so weak. However, I would argue that given overall market sentiment in 2014, gold has performed very well. Gold analysts examine the price of gold in dollars, why not? That is the international medium for gold. It is the price most people around the globe watch - gold in dollars.
Consider the Russian who holds some gold these days. The ruble has moved from 33-1 against the dollar at the beginning of 2014 to over 60-1. For that investor, gold is not down on the year; it is up big in rubles - a godsend to the Russian with the presence of mind to protect wealth. That is an extreme example.
Let us look at gold in euros. Gold in euros closed on December 31, 2013 at 874 euros per ounce. As of the close of business Friday, December 19, gold in euros trades at 977 euros per ounce.
Gold in euro terms has appreciated by just under 12% in 2014.
Is it a down year in gold? I guess that depends on where you stand.
"A word to the wise is infuriating"
Fear and loathing in the precious metals markets, as those of you who have read Hunter S. Thompson are keenly aware, is a title I pilfered from the late author, as is the quote above. It is a great title that explains so much about human emotion and drive. Whether it is fear and greed or fear and loathing, the precious metals have a little of both going on. On a historical basis, we have seen divergence in this sector extend over the course of the year. As the year draws to a close, these inter-commodity relationships have extended to the widest levels of the year.
A word to the wise for the precious metals bulls and bears out there -expect the unexpected in 2015. The inter-commodity spreads between gold and its precious cousins are telling us something important. Either gold is too expensive, or silver and platinum are too cheap on a historical basis.
You can trade that! Each camp has great arguments. The bulls will say that the printing presses in the US that ran nonstop for years have a price down the road - inflation. Now the printing presses in Europe are gearing up to do the same thing. Fiat currency is intrinsically worthless. The bears will counter that the current global economic condition is a path to continued deflation. Deflation will deflate the value of everything, including precious metals.
The bulls fear, the bears loath. I am afraid that for both camps, my word to the wise will be nothing more than infuriating. As I wrote at the beginning of this treatise, what do I know? I've only been trading these metals for 32 years.
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