Precious Metals Consolidation

Near-term liquidation in gold is possible, but the cyclical bull market will remain intact.

Net speculative positions in gold

According to our Commodity & Energy Strategy service, precious metals are trading more like liquidity plays than “safe havens”. Hence, speculative liquidation and a dollar bounce alone are sufficient to spark corrections in these metals. Editor: This is an important point and it’s one that is often missed by analysts. Gold is one of the most liquid global assets and when financial institutions need to raise cash quickly (for example to cover losses) gold is often one of the first assets they liquidate. This means that in periods of increased financial stress and market volatility the price of gold can fall sharply. However as we saw in 2008 it is the paper price of gold, i.e. the COMEX futures price, which falls while the physical price decouples and remains much higher. The paper futures market dominates the physical market because it is so much bigger. For example, it is not unusual for the entire annual gold production can be traded in the paper market in just two days.

Nevertheless, the staying power of any liquidation should prove limited beyond the next month or two. The underlying trends in gold and silver will be influenced by the continued low level of interest rates and central bank efforts to expand liquidity.

As long as interest rates remain far below historical norms, the dollar will have difficulty rising significantly and funds will continue to flow into precious metals ETFs. Moreover, platinum and palladium stand to benefit when the depressed global auto demand cycle normalizes – a process that should begin in 2013.

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