Precious Metals Under Pressure: So What!?

May 8 2017

93.8 percent. That is how likely the market thinks another Fed interest rate hike in June is, after the bank left rates unchanged last week. Because of these expectations, precious metals were hammered down. What could we conclude from this? And is this decline of the past few days a sign of more bad news for precious metals prices?

The fact that precious metals prices tumbled is no surprise. The perspective of an end to expansionary monetary policy is, without a doubt, bad news for the precious metals market. The fact that the American dollar might appreciate, on the back of rising interest rates in the US while rates remain at rock-bottom in the Eurozone, is an additional source of bad news for precious metals.

Given that France will not end up with an anti-euro president – something the market was not fully sure of a couple of weeks ago – does not help either. The threat of a French exit from the Eurozone, what in fact would mean the end of the common currency, has therefore practically vanished. Put differently: an important source of enormous political and economic uncertainty has dried up. As a result, the need for buying gold and silver has, according to the opinion of many, become less urgent. In reaction to all these developments, the gold price had its worst day in almost six months.

Fans of technical analysis have surely seen that the gold price has dropped below both the important 50-day moving average and 200-day moving average, and is currently flirting with its 100-day moving average, which is around 1,221 dollars per troy ounce. Some analysts expect a further drop to 1,200 dollars per troy ounce or even a decline toward 1,000 dollars.

Corrections Are Part of Life

Could this happen? Of course: every price, and therefore also the gold price, can go up and down. However, a price decline does not mean an upward trend has come to its end. No price ever goes just up or just down. In every trend, periods exist during which the underlying price acts like a salmon: the price “swims” temporarily against the current.

The last few months, gold prices have risen quite a lot and therefore a correction should not be surprising. That would be normal. What is also normal, is the fact that investors in gold tend to extrapolate the most recent price movement. When gold prices rise, they expect a continuing rise and when a decline sets in, many think rather quickly that the decline has just begun and that it will become worse.

As mentioned earlier, it can also be the case that the recent drop in precious metals prices carries on and pushes gold prices below 1,200 dollars and toward 1,100 or even 1,000. But …

This is where the fundamental difference between investors and speculators comes into play. Some investors get into gold and silver to earn short-term profits, while others with a long-term horizon buy gold and silver primarily as an insurance against inflation and other economic misery over the long run. In short, the ones that mostly worry about protecting their capital.

Investors Are Not Created Equal

For that group it means: so what if the gold price drops to 1,100 or 1,000 dollar? Sure, it would not be pleasant news, your investments are incurring paper losses. But the ones that have a long-term investment horizon and are mostly worried about protecting their capital, view the correction rather quickly as a good opportunity to take out the earlier mentioned insurance at a lower price by buying gold. Considering the long run, it does not make a great difference whether someone pays 1,200 or 1,100 per troy ounce.

Because what else remains unchanged besides the interest rate after the Fed-meeting last week, are the following few things.

In the first place the fact that the era of very loose monetary policy continues unabated. Even if the Fed raises the official rate twice more this year and repeats the same thing three times next year, the real interest rate will be close to zero percent. That is, from a historical point of view, good news for precious metals prices.

In addition, the odds are quite high that the Fed´s monetary policy must be made even looser. The US economy is fragile and not much is needed to push economic growth down. The same goes for inflation. The first quarter of this year proves my point. Economic growth came in significantly lower than in the last three months of last year. The fact that the Fed said last week that they view this slowdown in growth as a temporary setback, does not necessarily mean they are right (more on that next week). The bank has anything but an excellent track record when it comes to forecasting growth.

Last but certainly not least: the debt problem of Western governments has not gone away. Better yet, it might even be more acute than a few years ago. After all, the debt is considerably higher than at the beginning of the crisis, while the ability to service that debt (that is, the potential growth) is lower as a consequence of the long-term damage caused by the crisis. Economic growth seems to be substantially lower than what we were used to during the pre-crisis era. That means that the one solution for getting (partly) rid of the debt that governments resort to ever since governments first existed, is more interesting than ever: prolonged and higher than normal inflation. And thatthat is good news for precious metals. At least from the point of view of someone investing for the long run.

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