by Dominic . Picarda
Gold and silver have provided some of the best spread trading opportunities going in 2011. Their rallies have generally been long and powerful, delivering excellent returns to those who bought in at the right moments. However, the recent sharp pull back to around $1,530 over the weekend of the 24th / 25th September provided a stark reminder that no market is safe from large falls. Even with this market correction, I believe that both from a fundamental perspective and a charting viewpoint, these metals remain poised to make further gains.
The evidence shows that the driving force behind precious metals’ prices is cheap money. As long as interest rates remain at very low levels, the prospects for gold and silver look good. Specifically, their prices get a boost when interest rates are below the rate of inflation, as they have been for much of the time over recent years. Negative real interest rates make precious metals a much more attractive alternative to holding cash, for obvious reasons.
With the debt crisis far from over and many developed economies flirting dangerously with recession again, negative real interest rates are set to stay for the foreseeable future. America’s Federal Reserve has already signalled its intention to keep rates close to zero into 2013. I believe that the Bank of England is also unlikely to raise rates any time soon, while both institutions are officially contemplating further quantitative easing, which results in longer-term interest rates falling.
Beyond the immediate future, keeping interest rates below inflation is almost certainly central to the authorities’ ultimate plan for solving the debt crisis. Persistently negative real rates would steadily erode the value of the giant debts that governments and households are currently struggling with. This strategy was employed to ease the burden of indebtedness in the decades after World War Two, and led finally to the inflationary crisis of the 1970s and the last episode of global instability which drove up precious metals prices.
A deepening of the crisis in the Eurozone is another major risk for late 2011 and early 2012. Further bailouts are likely to be required among one or more of the most vulnerable members of the single-currency club, particularly Spain, Portugal, Italy, Greece and Ireland. However, appetite is waning for ongoing assistance to these nations among the voters of Northern Europe. In such an environment, the Euro could come under intense selling pressure once more, which in turn would likely boost gold further.
At moments of greatest fear, gold is likely to prove a safer-haven than silver. This is partly because gold is a more liquid market than silver, and investors crave liquidity at times of intense stress. That said, though, I project plenty of upside potential for silver. As of early September, gold looked overbought on a weekly and monthly view, whereas its semi-precious peer does not. Still, when gold experienced a significant pullback, silver was also dragged down in sympathy.