The action has been weak within the range.
Silver says below $880.
Platinum says below $880.
Few care about gold and the dollar is king.
Long-term it will be a buying opportunity.
It is a bold call at this point to publicly state that I see the price of gold falling, not just below $1100 or $1000 per ounce, but to $880. The yellow metal spent the greater part of the new millennium rallying. Back in 2001, the yellow metal with a storied history as a means of exchange and a store of value traded all the way down to a price of $255 per ounce. At that point, many considered the precious metal a barbarous relic of years gone by.
While Central Banks around the world continued to hold gold as a reserve asset, a currency reserve, the new generation of these bankers did not really believe in the asset that for thousands of years served as the ultimate currency. The full faith and credit of governments around the world was behind paper currencies and that seemed to be good enough for the masses. In a display of disdain for the yellow metal, the nation at the very hub of the international gold market sold half of their reserves of the metal.
The 'Brown Bottom' in gold was established when the British Chancellor of the Exchequer Gordon Brown decided to sell half the UK's gold reserve in a series of auctions between 1999 and 2002. Brown sold at the lows; many of us who have traded commodities for decades know how badly that feels. Many commodity traders have been relieved of responsibilities for buying the highs or selling the lows in a commodity market. In a display of typical political rationalization, the UK did not fire Brown for selling the lows; they promoted him to Prime Minister.
In the years that followed gold's "Brown Bottom" the yellow metal embarked on a rally that few expected. The price broke through the $400 barrier in 2003, by 2005 gold traded over $500 and in 2008 the 1979-1980 highs gave way to prices above $900 per ounce. As the global financial crisis of 2008/2009 caused a brief selloff back down to the $600 level, quantitative easing and a general environment of easy money or low interest rates turbo charged gold in the years that followed. By September 2011, the yellow metal surpassed $1900 per ounce. Then the music abruptly stopped. Since 2011, gold has been making a succession of lower highs and lower lows. Most recently, the precious metal has been stuck in a trading range.
The action has been weak within the range
Low interest rates and a weak U.S. dollar coupled with fear of economic collapse catapulted gold into the stratosphere. Today, uncertainty in terms of the future, a rising dollar and the prospect for higher interest rates has taken some of the luster off the yellow metal. The market has achieved a balance between bulls and bears over much of 2015. Each time gold rallies it looks like it will break through upside resistance and resume the upward momentum witnessed during the pre-2011 highs. However, each time the price of gold dips towards support it tarnishes and begins to look like that barbarous relic that Gordon Brown purged from the UK's coffers over a decade ago.
Several signs have been flashing for the past year that gold has become too big for its britches, that it is too expensive relative to other asset prices and that eventually the price needs to adjust lower. That time may be just around the corner now. The divergences in the precious metals sector weigh heavily on the price of gold and could push the yellow metal off the edge of a cliff.
Silver says below $880
The silver-gold ratio represents the number of ounces of silver value in each ounce of gold value. You can calculate the ratio by dividing the price of one ounce of gold by the price of one ounce of silver. Over the past 40 years, the average level of this price relationship has been 55 ounces of silver to each ounce of gold. Over the past four decades, the ratio has traded as high as 93.3:1 (in 1990) and as low as 15.5:1 (in 1979). The quarterly chart below illustrates the price history.
As you can see, over the long haul, each time the silver-gold ratio traded below the average rate of 55:1 it reverted to the mean level. Each time it traded above that level, it did the same. Today the ratio stands at 74.4:1, clearly higher than the long-term norm. On a historical basis, this tells us that either silver is too cheap or gold is too expensive. At a silver price of $15.85 per ounce, a reversion to the mean reflects a gold price of $872.
Platinum says below $880
The platinum versus gold spread is the price differential, per ounce, between the two precious metals. The quarterly chart of this relationship highlights the price history between platinum and gold
Platinum is currently trading at an $87 dollar discount to the price of gold. Since 1987, platinum has rarely been cheaper than gold. That is because platinum is a rarer metal. There is approximately 250 tons of platinum production each year compared to 2,800 tons of annual gold production. The vast majority of platinum production in the world comes primarily from two countries, South Africa and Russia. Gold's production is ubiquitous. Due to its rarity, platinum is more expensive to produce than gold.
Finally, platinum has many more industrial applications on a per ounce produced basis than does gold. Therefore, it makes intuitive sense that platinum should trade at a premium to gold. The largest discount of platinum under gold since 1987 has been $200 in 2011 and 2012. The largest premium for platinum was in 2008 at $1,200. Today, at an $87 discount, either platinum is too cheap or gold is too expensive on a historical basis. Thus, based on long-term historical norms, the price of platinum today at $1084 per ounce implies a gold price of $884.
Few care about gold and the dollar is king
Everyone loves a bull market. Gold was on center stage between 2004 and 2011 as the price rose and volatility dominated business news headlines. It took a while for the shine to come off gold, but in the aftermath of the highs, gold has taken a backseat to many other assets.
It is not that no one cares about gold these days, but less people certainly have the yellow metal on their radar than in the past few years. The reason is the poor performance of the yellow metal. Open interest, the total number of long and short positions in the futures market, highlights that there is less interest gold these days
The quarterly COMEX gold futures chart above shows that open interest peaked at 612,454 contracts in 2010 as the price of gold rose. Since then, open interest has dropped to 436,180 contracts -- a decrease of 28.8%. Meanwhile, the price of the yellow metal has dropped just under 39%.
Oddly enough, both silver and platinum futures currently have the largest open interests in history. Platinum is currently less than half the price it was at the highs in 2008 ($2308.80 per ounce) but open interest back then was 11,864 contracts in the NYMEX platinum futures market. Today, platinum open interest stands at 82,384 contracts -- an increase of almost 600%. When it comes to silver, at $15.85 there are 198,578 contracts of open interest in the COMEX silver futures market. When silver traded to highs of $49.82 per ounce in April 2011 open interest stood at 110,978 contracts. Open interest today is almost twice what it was when silver was over three times higher than the current price level.
The divergences in price coupled with the divergence in open interest highlights that something is out of whack in the precious metals sector these days. This tells me that a big move is on the horizon. The price divergences point a mean reversion in the historical price relationships between platinum, silver and gold. This is likely to translate into a lower price for gold. Action in the U.S. dollar is supportive of this view.
The U.S. dollar index futures contract rallied over 27% between May 2014 and March 2015. The dollar is the pricing mechanism for most commodities and precious metals are no exception. A stronger dollar is bearish for commodity prices and silver and platinum have taken it on the chin during the recent rally. Rising interest rates in the U.S. are likely to power the dollar even higher.
After all, increasing the yield on a currency whose path of least resistance has been higher adds more fuel to the fire. The Federal Reserve has been stalling as far as raising short-term rates but one thing is for sure, they are currently historically very low. Given relative strength in the U.S. economy, the downside in interest rates is almost zero and the upside is explosive.
Recent Fed comments lead me to believe that a symbolic 25 basis point rise will come in September or December this year. Meanwhile, longer-term rates are not sitting around waiting for the Fed. A quick look at the 30-year U.S. bond futures contract highlights this point.
The daily chart of the active month September 30-year U.S. Treasury Bond futures shows that since trading at 165 7/32 on April 3, 2015, these long bonds have fallen to the 149 level. This means interest rates have started to rise. Higher interest rates are a huge negative for the price of gold. Gold must compete with other assets for investment flows. Since gold pays no rate of interest, a higher interest rate environment raises the cost of carry for the yellow metal thus decreasing investment demand. Gold goes the way of investment demand. Lower investment demand makes gold heavier and more likely to fall.
Higher interest rates will support the dollar, which could be experiencing a period of consolidation after making highs in March. Rising interest rates in the U.S. coupled with a strong dollar and the prospect for even more strength in the greenback are negative for the price of gold.
Long-term it will be a buying opportunity
Gold has a lot going against it these days. Divergences with other precious metals are flashing a warning signal for the price of the yellow metal. The current price of silver implies a gold price of $872. The current price of platinum implies a gold price of $884. That is why I believe that the sweet spot for gold right now is the $880 per ounce level. It is just the case of a reversion to the mean. Rising U.S. interest rates and a stronger dollar are likely to be the impetus that gets gold moving lower in the near future. That is why I am making this bold call at this time.
While I am probably more bearish than any other analyst out there these days, I believe that when gold corrects it will create an amazing buying opportunity. Monetary policy around the world has been to print money or fiat currencies to stimulate economies. We saw this in the U.S. as quantitative easing kept money cheap for years now. Even though quantitative easing in the U.S. has ended and even as rates begin edging higher, rates will remain low on a historical basis, for a very long time to come.
Europe began mimicking U.S. QE policy this year, the ECB program runs through 2016 and extensions are possible if not probable. China has been stimulating that nation's economy by lowering interest rates. Thus far, in 2015, China has cut rates three times. These chickens will eventually come home to roost. Artificially low interest rates is inflationary, by definition. There is often a lagged effect between monetary policy and its ultimate effects. It is likely that all of this easing and cheap money will cause a bout of inflation down the road.
In physics, every action has an equal and opposite reaction. If this holds true in economics, a period of unprecedented inflation will follow the recent (and present) period of unprecedented low interest rates. When that happens, gold will shine again. I see gold dipping below $900 bucks however, when it does be sure to snap some up for the rainy day that is almost sure to come.
In the meantime, if you are skittish about shorting the yellow metal consider spreading a short against a long in platinum or silver as a mean reversion trade. Additionally, given gold's recent tight trading range, volatility is relatively low. This makes options cheap and put options could offer amazing returns when gold begins to fall under the weight of some very bearish fundamental and technical factors. The only thing that would negate this view would be if gold were to trade above $1240 or if we see a sudden break of upside resistance in platinum or silver.
Additional disclosure: The author always holds part of his portfolio in precious metals. That percentage is subject to changes in market conditions.
