What the Market's Mayhem Means for Gold and Silver

As the Dow Jones Industrial Average plowed its way to a gut-wrenching 512-point collapse Thursday, thousands of Fools came together in a live chat session to assess the damage. The number of questions relating to gold and silver suggests that Fools sought to refocus their outlooks for precious metals after witnessing the widespread carnage. This article will seek to pick up the scattered puzzle pieces and fit them all back together.

Some reassembly required
Before we complete the puzzle to yield a clear outlook for gold and silver, we need to gaze at the pieces and study their contours. This week has witnessed an array of powerful developments with widespread implications for currency markets, which of course have direct bearing on the monetary metals gold and silver.

I've documented a continuum of developments over the past several years that have collectively formed the fundamental pillars for this secular bull market in precious metals. This week saw the addition of a pathetically weak attempt to dial back projected spending increases in the U.S., further European debt contagion placing the large economies of Spain and Italy in the crosshairs, revelations of meaningful gold purchases by emerging-market central banks, and currency interventions by both Switzerland and Japan in the latest chapter of the global "race to debase."

That latter point is critical to understanding the resiliently bullish outlook for gold and silver. One might say it's the primary puzzle piece around which all others are arranged. You see, the still-deepening structural imbalance within the world's leading reserve currency (the U.S. dollar), together with the acute debt distress across the Atlantic blazing a similar trail for the euro, simultaneously herald the unavoidable devaluation of those two major currencies. Also, these conditions are, in turn, effectively forcing nations around the globe to engage in deliberate, competitive devaluation of their own currencies to defend their respective economic growth potential.

Marc Faber offered this explanation of the outlook for sustained U.S. dollar devaluation:

The trouble is that governments can default in two ways. Either they just stop paying the interest and there is a debt restructuring, like Argentina went through; or they just pay the interest and the principle eventually, in a worthless currency. That's the way the U.S. will likely do it.

Echoing a sentiment I expressed here back in March, Faber added, "Buying Treasuries as a safe haven is no longer a smart play".

Since currency valuations are all relative measures against other currencies, devaluation of the major reserve currencies can cause unwelcome appreciation elsewhere. Capital that had flowed into the Japanese yen or the Swiss franc in search of relative strength was forcibly evicted this week through intervention. Every time those dynamics play out, the resurgent role of gold as the sole currency immune to such antics is elevated within the global financial system.

Stepping back from the completed puzzle
When you combine all the myriad factors impacting gold and silver prices to yield a cohesive and carefully prepared image, the result is a decidedly bullish outlook that I believe will make my $2,000 target price for gold look Foolishly conservative before all is said and done. Over time, I believe gold will come to be viewed as a greater safe haven than U.S. Treasuries and cash, given the unfortunate outlook for continued dollar devaluation and currency-driven stagflation. For now, those imperfect targets for capital that's fleeing risk remain the knee-jerk default for many money managers. In the near-term, then, I see the potential for counter-intuitive demand for U.S. Treasuries and sustained flows into cash, and recent gains by gold and silver make them an enticing target for liquidation. Furthermore, Europe's acute predicament is likely to weigh heavily on that currency for a time, creating the potential for a countercyclical rally for the dollar.

Moreover, gold and silver suffered some technical damage on heavy volume Thursday that must not be overlooked. The metals had already recorded powerful upward moves during the preceding weeks, prompting me to suggest to readers of my blog last week that raising some cash might make some sense. When indiscriminate selling takes hold of investors worldwide, technical indicators can become our best guide. I see some light support beneath gold near the $1,620 range, but if that were to fail I think we could see prices dip toward powerful support near $1,480. Silver, as usual, could be expected to experience larger swings on a percentage basis.

Far from attempting to time or predict a near-term bottom, I simply use those technical levels to inform my repeated efforts to buy into weakness after selling into strength. All the while, my core positions in gold and silver remain untouched because these near-term dynamics can easily be overridden by any number of potential developments on the macroeconomic stage. In a long-term bull market like the one ongoing for silver and gold, the trend is most definitely your friend.

The near-term picture grows far more compelling when we examine the shares of gold and silver miners, which incidentally are where I focus the vast majority of my own investment exposure to gold and silver. Along with every sector under the sun, these mining shares were blasted back into oblivion by the market's indiscriminate dash for cash. 

During late June, while gold hovered just above $1,500 per ounce, I remarked that gold stocks on the whole were priced about where I would expect them to be if gold were fetching only $1,250 per ounce. Presently, even with gold holding above $1,650 per ounce, Fools will find Freeport-McMoRan Copper & Gold (NYSE: FCX  ) trading lower still! If Goldcorp (NYSE: GG  ) was a gift under $50, it became an even greater gift near $45 Friday morning before an analyst upgrade crossed the wires. Yamana Gold (NYSE: AUY  ) is sporting a different sort of attraction, having weathered the sell-off with remarkable relative strength to hold above $13 per share. Once the near-term tide shifts back in favor of gold and silver equities, I expect this long-undervalued stock to prove a valuable outperformer.

As typically occurs during bouts of weakness for precious metals, silver miners bear the brunt of the selling to create some of the most enticing buying opportunities. Silver Wheaton (NYSE: SLW  ) enters deep bargain territory every time its share price dips beneath the prevailing long-term price for silver. Endeavour Silver (NYSE: EXK  ) continues to impress, Hecla Mining's (NYSE: HL  ) deep discount to fair value defies explanation, and Alexco Resource (AMEX: AXU  ) remains one of my top picks for the "poor man's gold".

After completing a puzzle, I like to step back a bit to appreciate the whole picture. Zooming out from the potential for further near-term weakness, I predict a long-term continuation of the trend whereby gold and silver are increasingly recognized as the most viable vehicles for protecting capital from the ravages of systemic currency distress and competitive global currency devaluation. 

Cash presents one alternative as a short-term parking spot for capital, but Bank of New York Mellon's incredible decision Thursday to charge fees to large cash depositors may nudge some of that capital in the direction of precious metals. U.S. Treasuries remain in high demand for now, but even the world's largest bond fund won't touch these highly unattractive assets with the negative realized yield. 

In the final analysis, the broader story for gold and silver is all about the resurgence of alternative, time-tested monetary instruments to step in as viable safe havens to an increasingly sour-tasting array of competing paper currencies and sovereign bonds. Because public debts continue to expand around the world, and paper currencies continue to devalue en masse, I believe the long-term upward trajectory for gold and silver remains etched in -- well -- metal.

Fool contributor Christopher Barker can be found blogging actively and acting Foolishly within the CAPS community under the username TMFSinchiruna. He tweets. He owns shares of Alexco Resource, Endeavour Silver, Goldcorp, Hecla Mining, Silver Wheaton, and Yamana Gold. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.


Read/Post Comments (12) | Recommend This Article (44)

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 August 05, 2011, at 5:29 PM, XMFSinchiruna wrote:

    By the way, a few successive closes above $1,665 could conceivably repair the near-term technical damage and render further corrective weakness less likely. In divining which of the two scenarios will hold sway, silver may ultimately be the one to watch. Unless silver can retake the $40 mark soon, I have to conclude that gold remains likely to correct as described above. Remember, periodic corrections are welcome developments within any secular bull market.

  • Report this Comment On August 05, 2011, at 5:52 PM, Frankydontfailme wrote:

    Thanks Sinch. A pullback is possible, evenl likely for the PMs. However, I have trouble seeing gold lower than 1600... especially with further easing coming along from Bernanke on Tuesday and sooner rather than later from the Eurozone. I don't see the fear trade subsiding quite yet.

    Silver could drop, but will find strong support near 36. Interesting that you tie gold price to silver price similarly to Eric Sprott. I never thought about a low silver price begetting a lower gold price.... not sure if I'm convinced.

    Thanks again

  • Report this Comment On August 05, 2011, at 6:03 PM, XMFSinchiruna wrote:

    Frankydontfailme,

    Please see this discussion here:

    http://www.fool.com/investing/general/2011/04/07/let-the-gol...

    and here:

    http://www.fool.com/investing/general/2011/02/11/3-imminent-...

    I strongly encourage you to see the relationship between gold and silver as a highly dynamic one, where either one can set the stage for a given shift of direction for the pair. The two metals are tied together by the slingshot effect. If a given move in silver has legs, it will impact the trajectory for gold, and vice versa.

    See here for another discussion of the slingshot effect:

    http://www.fool.com/investing/general/2009/04/03/an-asset-mo...

    Silver absolutely holds the reins at times. We've seen it countless times as the trigger to downside, in part I believe because institutional shorts have a much easier time moving the smaller silver market than gold.

  • Report this Comment On August 05, 2011, at 6:12 PM, XMFSinchiruna wrote:

    Also, franky...,

    As mentioned above, any number of potential macroeconomic developments, including a monetary policy action by the Fed, could take a gold correction off the table in a heartbeat. I personally don't anticipate any concrete announcements coming quite this soon.

    Also, do note that in the early stages of a real fear trade, of the sort we witnessed Thursday that incites indiscriminate selling, gold and silver can suffer in the short term as easy pickings for moves into cash or Treasuries.

  • Report this Comment On August 05, 2011, at 7:24 PM, Gonzhouse wrote:

    Great article Sinch. You are absolutely spot on with the fact that all fiat currencies are in a race to the bottom. And the US will ultimately pay back all its debt with continually devalued dollars: what other choice do we have? Everyone knows it, particularly China and India. That's why they are diversifying big time into precious metals.

    The EU crisis for Greece, Ireland, and probably Italy won't end anytime soon because they are boxed in. It used to be the countries would significantly de-value their currency, resulting in a sharp drop in imports with a corresponding surge in (now cheaper) exports. Since the PIIGS have adopted the Euro, they can't de-value. A technical default is the only solution left and that will not be pretty.

    Marry these 2 issues together, and anyone left with wealth is going to avoid currency investments. While gold and silver are the poster children for the place to put your wealth, all commodities are lined up as well.

  • Report this Comment On August 05, 2011, at 9:16 PM, t0bes wrote:

    I think most of us on this site aren't likely to panic and sell everything when an event like yesterday occurs. But I appreciate you, and the many other Fools right up to Tom and David, spending time to write such calm insightful articles.

    I just wish I had more funds to invest right now

  • Report this Comment On August 05, 2011, at 10:19 PM, skypilot2005 wrote:

    Sinch,

    Thanks, for the Macro review.

    It is very valuable for context when reading the reviews of the companies you write about.

    I like your use of “a pathetically weak attempt” as an accurate description of events.

    Sky Pilot

    Your Web Link Assistant

  • Report this Comment On August 06, 2011, at 4:41 PM, Frankydontfailme wrote:

    After thinking about it and reading those links, I have to admit that you're probably right about silver having the potential to lead gold lower.

    There are situations where they can decouple, nonetheless.

  • Report this Comment On August 07, 2011, at 10:46 AM, XMFSinchiruna wrote:

    Franky,

    The tether that joins gold and silver will stretch and contract, but you'll never see the two decouple to where the price of one fails to retain relevance to the price of the other.

  • Report this Comment On August 07, 2011, at 11:36 AM, skypilot2005 wrote:

    Yukon-Nevada Gold Corp. Plans to Enter Into A Prepaid Forward Gold Purchase Agreement

    http://www.yukon-nevadagold.com/s/NewsReleases.asp?ReportID=......

    http://www.reuters.com/article/2011/08/03/yukonnevada-idUSL3...

    UPDATE 2-Yukon-Nevada plans $120 mln prepaid gold buy deal with Deutsche Bank

    Deutsche Bank -- which owns more than 10 percent of Yukon-Nevada -- will lend the money to Queenstake.

    About $26 million of the loan proceeds will be used to repay the senior secured notes issued to noteholders led by Sprott Asset Management LP in August 2010. Sprott owns 14.47 percent of Yukon-Nevada and is the second-largest shareholder of the company, according to Thomson Reuters data.

    The company, which has a market value of about C$423 million, will not pay any interest to Deutsche Bank during the term of the facility.

    Sky Pilot

    Official Web link Assistant to Sinch

  • Report this Comment On August 07, 2011, at 11:37 AM, skypilot2005 wrote:

    August 3, 2011

    Tyhee Starts Drill Program at Yellowknife Gold Project

    http://www.tyhee.com/investors/documents/110803ClanDrillb.pd...

    Sky Pilot

  • Report this Comment On August 09, 2011, at 11:39 AM, paddlinfaster wrote:

    I've been reading all the MF articles about gold since late 2008 & one thing I still don't understand is why all the gold miners are either flat or have gone down this year while gold itself has continued its march ever upward. Can you explain why this is?

    I know you've written about this, but I still don't get it. Thanks for your patience.

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