The Untold Story Behind This Golden Breakout

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It was surreal.

Throughout the financial media, commentators and analysts appeared at a loss for words Thursday to identify potential catalysts for the abrupt surge in gold and silver prices.

The equity markets felt calm, the dollar's value against foreign currencies was not tanking, and the bond markets offered nary a clue. Gold was the hot topic of the day, but insightful discussion remained remarkably absent.

I generally consider it a trap to ascribe daily market oscillations to specific causal factors, but when a clear technical breakout carries even large-cap mining shares like Newmont Mining (NYSE: NEM  ) to double-digit percentage gains, the discussion must dig deeper than the momentum-buying and short-covering explanations that dominated the airwaves.

Gold had indeed been primed for a technical breakout, as I pointed out in an article drafted before the move began. However, a long list of fundamental drivers supporting higher gold and silver prices leads this Fool to conclude that the move will have some legs.

In no particular order, here are some of the more recent fundamental catalysts I've identified:

  • In a move that Western media sources have failed to cover adequately, the agency responsible for oversight of China's state-owned enterprises (SOEs) recently warned foreign financial institutions that SOEs will be permitted to walk away unilaterally from failed OTC derivative hedge contracts.
  • China will purchase up to $50 billion in Special Drawing Rights (SDRs) from the International Monetary Fund. Fools will recall that China has explicitly called for replacing the U.S. dollar as the world's reserve currency in favor of these SDRs. Russia and India have likewise indicated an interest purchasing SDR-denominated IMF bonds.
  • China's ramped-up dealmaking activity for resource-related assets around the globe reflects an official policy directive. Recent loans or investments by Chinese entities relating to foreign resource assets are themselves nearing the $50 billion mark. China has indicated that foreign reserves will be deployed in support of this broader initiative, representing another clear diversification away from U.S. dollar exposure.
  • The Democratic Party of Japan emerged as the clear victor in last week's election, ending a 15-year reign of the Liberal Democratic Party. Fools will recall that the Democratic Party of Japan's finance chief advised his nation last May to cease purchasing U.S. Treasury bonds unless those bonds are denominated in yen.
  • China is considering a ban on rare-metal exports. More than 95% of the world's supply of rare-earth minerals comes from China, so the move places global manufacturers of everything from hybrid cars to cell phones in a difficult position. China is also the world's leading producer of gold, and this move raises this Fool's eyebrow as a precedent for China's restricting exports of key strategic resources.
  • China is actively encouraging its 1.3 billion citizens to invest in precious metals. I have viewed excerpts from state television touting the extraordinary relative value of silver to gold given the large deviation from the historical ratio between prices of the two metals. Because gold and silver are surprisingly small physical markets, even a minor uptick in investment demand could fuel sizeable price increases.
  • Hong Kong is repatriating its physical gold reserves from London to high-security vaults at home, and it is inviting the region's central banks to store their bullion there. Announced just this week, the move deals a significant blow to London's historical role as a global hub in the precious metals market, and it raises the specter of a potential price-settlement hub in Asia to rival the New York and London daily spot-price fixes. The Hong Kong Monetary Authority is also targeting a new gold bullion ETF using the new vault as a repository, which would remove yet more physical supply from the market. The SPDR Gold Shares (NYSE: GLD  ) reports holding 1,078 tonnes of gold, slightly more than China's last-reported gold reserves.

It's no coincidence that all of the above developments -- which can be considered potential near-term catalysts boosting the strength of this breakout in gold and silver -- hail from Asia. This Fool has observed China, which holds more dollar-denominated debt than any other nation, steadily ramping up both its rhetoric and its actions in a clear vote of no confidence in the greenback. I view an end to this 18-month correction in precious metals as imminent, and I concur with the likes of Jim Rogers that the dollar remains between a rock and a hard place.

Where to invest
If you lend credence to these and other fundamental factors supporting a continuation of the eight-year bull market in precious metals, then you'll want at least some investment exposure to gold or silver. With commercial production at the world-class Penasquito mine slated for early 2010, I consider Goldcorp (NYSE: GG  ) the best-positioned of the large-cap miners. I also find it interesting that shares of Yamana Gold (NYSE: AUY  ) , which trade around $10.50 now, fetched $19 before the correction took hold in March 2008, as the company has only strengthened in the meantime. Golden Star Resources (AMEX: GSS  ) is just one of many promising junior miners that have broken out impressively this week.

For silver, I continue to highlight Silver Wheaton (NYSE: SLW  ) for its fixed, low-cost business model. Coeur d'Alene Mines (NYSE: CDE  ) is enjoying quite a resurgence as two huge mines rake in the cash flow.

As this bull market for precious metals roars onward, stay tuned for additional Foolish coverage.

Gold is a hot topic on the blogs at Motley Fool CAPS. Join the free service today, and see just how many Fools are taking the long view when it comes to investing in gold. The "Gold" tag at CAPS lists 44 potential investments, and you'll find Christopher's comments on most of them.

Fool contributor Christopher Barker carries a silver coin that reads, "Honest value never fails." He can be found blogging actively and acting Foolishly within the CAPS community under the username TMFSinchiruna. He tweets, too, and he owns shares of Agnico-Eagle Mines and Silver Wheaton. The Motley Fool's disclosure policy is 0.999 pure.

Read/Post Comments (3) | Recommend This Article (46)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On September 04, 2009, at 11:50 PM, silverincite wrote:

    I read most of that news on Jim Sinclair's website, otherwise I haven't seen anything in the local media.

    It was good to see so much volume with the price gains.

    Thanks for compiling it all together!

  • Report this Comment On September 07, 2009, at 12:59 PM, Retirefunds wrote:

    I agree overall that investors need at least some exposure to gold. I have recently bought gold in the form of a small company drilling in Timmons, Ont, Canada. At the same time I sold off some bank stock and solidified some gains from the summer rally.

    The fact the Chinese Government is advising their own citizens to invest in gold and silver is definitely an omen for the usd decline. Good report.


  • Report this Comment On September 07, 2009, at 10:46 PM, FiatFaux wrote:

    The Supply/Demand dynamics of the increasingly acute Silver Shortage, along with...

    China's "no confidence" dumping of USDollar/Treauries, while pushing Bullion via State TV to 1.3 Billion Chinese sets the stage for A Silver SkyRocket to launch very soon like A Chinese Bottle-Rocket, but long before New Years Day!!!

    Compare Silver Wheaton (SLW) silver royalty co & SilverCorp Metals (SVM- largest Chinese Primary Silver Miner) to Chart of SLV/GLD & see some serious Leverage!!! Gold/Silver Ratio Gap Closure?? About 1x70, historically 1x20 or 1x10: Silver costs SLW & SVM as low as about $1-$2/OZ!!


    Chinese Students laugh at Timidy'$ "Fiscal Responsibility", then China's unprecedented Warning: Wall St. Hedge Defaults!! Can the Big Ben Bernie Banks like JPMorgan survive when their huge naked Silver Shorts fall off, without A TARP-2?? Can Big Ben Bernie'$ FED print enough green to cover coming massive losses, amidst the instant Hyper-Inflation?

    GOT GOLD? Better yet, Scarce Silver?? The BRIC'$ are trading all that fiat paper "money" for Real Money... FAST!!!

    Breakout? Silver over 1 Year Highs 3 days Running!!!

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