Precious Metals Investments
Gold, Silver, Platinum, and Palladium
The precious metals complex looks a little discombobulated lately, with each metal playing from a different page of sheet music.
• Gold, after hitting a six-month high of $1,391 mid-March, quickly lost over $100 in two weeks to below $1,280 by the start of April, and has been stuck in a sideways range since then.
• Silver, after hitting a four-month high of $22.04 at the end of February, has been dropping ever since, losing more than 11% to its current $19.50.
• Palladium, after very volatile action since the beginning of 2013, bouncing between $680 and $760 at least 9 times in moves greater than 10% each time, finally broke through its upper band of resistance at the end of February, reaching $800 earlier this week.
• Platinum, after traversing some rolling hills of its own between $1,350 and $1,550, has peacefully settled at the midway point of $1,450 like a tired dog circling around and around until he plops himself down in the middle of the mat.
Some up, some down, some sideways – they’re like a band of musicians at the end of a gig at a club that gave them open bar access. Let’s have a look at the music each is playing and try to predict which end of the stage each one will fall over.
Strikes and Conflicts
Both platinum and palladium started their latest upward bounce off of their long-term support levels during the second week of February, shortly after a major walk-out by miners in South Africa.
On January 23rd, some 70,000 miners and 1,800 refinery and smelter workers walked off their jobs and have yet to return, crippling the output of the world’s top three platinum producers - Anglo American Platinum, Impala Platinum Holdings Ltd., and Lonmin Plc, who together account for 60% of global platinum production.
While platinum jumped more than 8% by early March, it has since given back 4% to stabilize at the midpoint of $1,450. But prices have been rising once again over the past week as the violence escalated among the striking miners themselves, as strikers attacked and killed several miners returning to work.
Palladium’s price similarly jumped in February on the back of the strikes, South Africa being the metal’s second largest producer. But where platinum stabilized, palladium just kept right on climbing on the heat of another conflict, that between Ukraine and Russia – the world’s largest producer of the metal. From the start of South Africa’s strikes, through Russia’s annexation of Ukraine’s province of Crimea, and into the increased pro-Russian activity in eastern Ukraine, palladium has soared a total 12% in four months.
With no end in sight for either the strikes in South Africa or the conflict in Eastern Europe, analysts expect the upward price movements of platinum or palladium to continue, as the metals’ supply diminishes and stockpiles slowly deplete.
“We believe the market is working under a structural production/consumption deficit,” chief precious metals analyst at HSBC, James Steel, pointed out. “We are therefore bullish medium- to longer-term.”
Lusterless Gold and Silver
Yet with such tensions in key precious metals spots around the world, not to mention the increased risk of a hot conflict between Europe and Russia, what accounts for gold’s and silver’s lusterless performance over the past two to three months?
“What's pointing to lower prices are the stronger equity markets, the firmer dollar,” answers Commerzbank analyst Daniel Briesemann.
The U.S. dollar’s strength is also tied to the growing tensions in Ukraine, which has been weighing down on the Euro. After falling 3 cents during March – half on the build up to Crimea’s annexation and half afterward - the Euro spent the month of April reclaiming those losses back to the $1.40 USD level.
But just over the past two weeks as another pro-Russian referendum threatens to tear Ukraine apart, the European currency lost those same 3 cents again plus a little more, strengthening the USD and softening the value of gold and silver, which are priced in USD.
As Briesemann noted, gold and silver prices were further pressured by strong equity markets, as the S&P 500 broader market index soared 160 points from the bottom of February’s mini-correction to a new all-time high of 1,900 yesterday - a gain of 9.1% in just 10 weeks. Since investors are not looking for safety, gold and silver were pushed aside in the rush for stocks.
Dampening gold and silver all the more have been the five-week general elections in India, which imposed tight restrictions on the carrying of cash in an attempt to prevent bribery and vote-buying. India’s gold imports fell from an average of 80 tons per month at the start of 2014 to an estimated 20 tons for both April and May combined.
But two major events look poised to turn gold and silver around.
A Possible Turnaround?
The first major event likely to turn the tide for the top two precious metals has already transpired… the end of Indian elections on May 12th. Not only is gold consumption in India expected to quickly return to normal levels, but there should also be some additional buying as purchases postponed during the past two months are placed. Further buying is expected in July and August in preparation for the start of the annual Indian wedding season in September.
Over this same period, a second major event halfway around the world in the U.S. could light a second fire under gold and silver prices - the long awaited correction in equities. If the two metals have been hurt by rising stocks, falling stocks should have a lifting effect.
One important indication that such an equity correction is looming is the flow of money in and out of key markets. While major stock indices like the S&P 500 and the Dow Jones have been setting new highs, U.S. Treasury bonds have also been climbing higher. This isn’t supposed to happen.
Normally, money flows from one to the other – from the safety of bonds to the risk of equities when markets are bullish, and back into safety when markets are bearish. How, then, could both equities and bonds move up at the same time?
If we look at the markets a little more closely we find they are not all moving the same way. As depicted in the graph below, while the S&P 500 and the Dow Jones have been climbing to new highs, the Nasdaq and Russell 2000 have been falling. I assigned the Nasdaq and Russell 2000 the colors of black and blue since they have been battered and bruised pretty good.
Not depicted above is the 10-Year Treasury’s yield which has fallen from 2.81% to 2.58% over the past six weeks.
What does it all mean? The money is rotating out of risk and into safety. The tech-heavy Nasdaq and the small cap populated Russell 2000 are high risk indices which run up the most when markets are hot, but fall the most when markets break. In contrast, the medium and large cap heavy S&P 500 and the large cap populated Dow Jones are comprised of the more stable stocks which hold up better during market corrections.
Looking at the graph, it is quite remarkable how closely the S&P and Dow have been following each other, with the Nasdaq and Russell 2000 almost joined at the hip. Toss in the recent flight to the safety of Treasuries and we get a strong indication – warning, even – of an impending market correction.
Perhaps the ole “sell in May and go away” word of caution will apply this year after all, after having skipped the last two. This is itself another sign of a correction ahead – our lack of a sizable correction in over two years, which raises the potential for the next correction to be more severe when it finally hits.
If the typical annual crunch from May to September holds true this year, along with strikes in South Africa, conflict in Ukraine, and the return of jewellery buyers in India – the back-half of 2014 could see a boost to the precious metals, lifting them out of their long multi-year slump.
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