Precious Metals

Patience Pays with Gold and Silver
by Eric McWhinnie - Wall Street Cheat Sheet

May 31, 2012

     

There seems to be no shortage of turmoil in the markets. The European debt crisis continues to remain in focus, while a multi-billion dollar loss by America’s largest bank does little to restore confidence in the financial system. Even Facebook, the most highly anticipated initial public offering in years, has failed to spark interest in equity markets. In the current situation, one might expect precious metals to perform well as investors seek safety, but the complete opposite has been true.

As the euro zone received more negative news on Tuesday, gold and silver slid further into the red. Gold futures for June delivery dropped $20 to close at $1,548, while silver futures fell 60 cents to finish below $28. Ratings agency Egan-Jones cut Spain’s credit level from B to BB- with a negative outlook. It was the third downgrade from the firm in less than a month. Reuters reported, “Much as it did in downgrades last week and in late April, the company pointed to deteriorating public finances and worries that the country will be faced with sizable payments to support its banking sector. Spain is battling a debt crisis that is shaking its government, banks and companies. The country will soon issue new bonds to fund ailing lenders and indebted regions despite borrowing costs nearing the 7 percent level that drove other states to seek a bailout.”

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Despite deteriorating public finances appearing in countries across the entire globe, including the United States, many investors continue to flee to the U.S. dollar as a safe-haven asset. The dollar index, which compares the dollar in a basket against six other fiat currencies, climbed to as high as 82.63 on Tuesday. The euro, which accounts for the majority of the dollar index, fell to its lowest level since July 2010 at $1.2458. “We are seeing the headline-driven market continue to prop up the greenback amid the growing threat of a Spain bailout paired with fears of a Greek exit,” explained David Song, currency analyst at DailyFX. Today, the dollar continues to charge higher while the euro sinks below $1.24. In fact, the yield on the 10-year U.S. Treasury note fell to its lowest level on record this morning, below 1.65 percent. More than half of the companies in the S&P 500 now yield more than the 10-year note.

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Much like the Facebook IPO, many investors have dropped gold and silver from their friend list. Both precious metals have erased gains for the year and are well-off their multi-month highs made in March. However, investors that have been riding the decade long precious metals bull market have seen this story before. The markets still perceive king dollar as the ultimate safe-haven because it is the cleanest shirt in the fiat currency laundry basket. Doubts surround Europe, China just announced its stimulus’ efforts won’t match 2008 spending and the Federal Reserve continues to send mixed signals on more quantitative easing programs. The current situation is somewhat reminiscent of 2008, when investors rushed into dollars as gold fell from $1,000 to nearly $700 per ounce and silver plunged from $21 to $9 per ounce.

Looking in the rear-view mirror, patience has clearly been a smart strategy for investing in precious metals. Gold and silver both skyrocketed off their lows made in 2008 as central banks turned to money printing as a band-aid for a bullet wound. The dollar is currently experiencing strength, but what happens when the Federal Reserve is forced to step in and apply more band-aids, as it did with QE1, QE2, Operation Twist and European swap lines?

While some may expect bullion demand to be significantly lower from falling gold prices, demand for gold as an insurance policy on fiat currencies remains high. For the first-quarter, gold investment demand jumped 13 percent to 389.3 tonnes, compared to 343.5 tonnes a year earlier. Earlier this month, Russia’s central bank also announced it will keep buying gold in order to diversify foreign exchange reserves. Even though precious metals can be volatile at times, it is better to have your insurance a year early than a day late.

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Disclosure: Long EXK, AG, HL, PHYS