A Melman Minute — April 15, 2013
| By | Leonard Melman |
|---|---|
| Date | April 15, 2013 |
The numbers which we are witnessing this morning relating to precious metals investments are staggering - and, regrettably, they are severely to the downside. As this is written early in the trading day gold's latest range is from $1,382-85 while silver has fallen to about $23.40 - down by more almost $3.00 per ounce. Crude Oil and Copper are also declining, adding to weakness in the entire commodity sector.
What follows is our attempt to evaluate where we are and examine what is different 'this time' and why bullish arguments based on lessons learned from previous golden bull markets have been derailed, at least temporarily.
GOLD AND SILVER - SELLING CLIMAX OR ???
Perhaps the most important question for precious metals investors and observers to consider is whether the recent sharp declines in gold, silver, platinum et al - and their associated shares - are taking the form of a 'selling climax' which will reverse powerfully to the upside and provide strong long-term investment opportunities - or could they be harbingers of even further weakness to come.
According to my interpretation of chart analysis, it is with regret that I conclude that all sorts of 'red warning flags' are flying' regarding the short to intermediate terms for the precious metals and their associated shares.
Please note the ten-year chart of Bank of America (symbol: BAC), a stock whose shares encountered waves of selling in late 2007 and 2008 which bear true similarity to recent action in the gold market. Like gold, BAC had enjoyed years of prosperity which culminated in the shares reaching over $53 at their 2006 peak. Like gold, that peak was followed by 18 to 24 months of 'fiddling around' at levels near but below that peak. Then suddenly, in late 2007, BAC shares plunged down through previous support near 40 and what followed was a debacle which saw the shares fall - although interrupted by periodic rallies - down to below $3 per share before the decline came to a genuine halt.
Obviously, the break below $40 in late 2007 was not a selling climax, but rather a warning that a dangerous market condition could be taking place. As an additional thought, it was the bottom near $3.00 that represented the selling climax and was followed by a "v-formation" reversal which saw BAC shares rise by 600 percent from that bottom within one year.
Now, please compare that action to recent moves in the chart of the price of gold.
Like BAC, gold had moved strongly for a period of years, achieving an all-time high. Then, a period of sluggish chart action ensued, lasting 18 to 24 months. Next, gold, like BAC in late 2007, has plunged dramatically below previous support which in gold's case had come in near the $1,500 level.
As I noted in a recent Melman Minute, in my opinion gold's chart action over the past couple of years resembled what has been termed a "giant over-hanging top". I believe that when a major topping formation such as that breaks down, the resultant market action is normally not consistent with a 'selling climax' laden with immediate opportunities, but rather a 'red warning flag' that high levels of caution would be in order.
There is no point in attempting to predict an exact number where gold will find a true and long-lasting point of reversal and I seriously doubt if gold will ever encounter the kind of selling which drove BAC's stock down by about 95% from its peak - but I do suggest that further important declines in the precious metals may take place and, therefore, potential investors should at least be aware of that possibility.
WHAT HAS GONE WRONG?
Of all the past golden bull markets, the one which left the deepest impression was the phenomenal run from $106 in August, 1976 to about $850 in January, 1980. Huge fortunes were made in relatively short order and it has been studied in detail to determine what factors led to that enormous rally.
One of the most important was inflation which reached an annualized rate of 20% in the USA by 1980 and which caught the attention of millions who had never previously given a moment's thought to economic matters. Therefore, the anticipated rate of inflation has remained a matter of great importance to precious metals analysts. At the moment, although anecdotal evidence suggest some strong inflation, virtually all official government data suggests inflation is under control.
However, it is worth noting that there are many economists who believe that inflation is more a matter of escalating monetary aggregates and on that score, there is a plenitude of evidence that rising inflation should become an increasingly positive factor for the precious metals.
Another issue of importance is interest rates and there are two important considerations. During periods of rising inflation - such as 1976 through very early 1980 - inflation-driven gains in interest rates can also be very positive for the precious metals. However, rising rates of interest driven by efforts to clamp down on the money supply - such as were observed from mid-1980 through the end of 1981 - coincided with negative performance in the metals. At the moment, interest rates are at historically low levels as are reported levels of inflation.
International tensions were also a substantial factor leading to January 1980 with the war in Afghanistan, the American refusal to participate in the 1980 Russian Olympics and the possibility of a direct confrontation between the USA and the USSR making daily headlines.
Today, we appear to have a growing sense of international confrontations with the North Korean - South Korean squabbles at the top of the list, including the potential (even if remote) for possible nuclear confrontation.
There is also the matter of security markets worldwide. From 1976 through 1980, these markets were moribund, idling time between 750 and 850 on the Dow Industrials and many market observers noted this indicated a general sense of pessimism among investors. Today's markets, on the other hand, are roaring ahead to all-time highs.
While there are other factors, these are among the most important and I would note a trend in news of late. Many of these factors have at times appeared ready to burst into prominence, generally in favor of the metals, but somehow any genuine crisis has been averted to date and I believe this has led to a growing level of scepticism which has now come to fruition in the form of a technical breakdown in the metals' price charts.
I would not be surprised if we are near the point where a 'snap-back' rally in both the metals and the mining shares will take place. In all likelihood, margin calls are beginning to diminish, technical selling will abate and a sense of panic will be followed by a sense of opportunity among some that this is the time to pick up 'bargains'.
The real test of the precious metals will take place in the form of that snap-back rally. If it is short-lived and does not rise to recover virtually all the recent losses, then I would offer the opinion that more selling, perhaps of a severe nature, will be in store. However, if the rally does recover that lost ground and then some, then a full resumption of the golden bull market may indeed take place.
As of 9:15 AM PDT, financial markets in the USA and Canada are joining action in the precious metals as they are declining sharply with the Dow Industrials down by over 150 points while Canada's TSX Index, more directly affected by falling commodity prices, is down by over 230. Gold is now trading nearly $100 lower than Friday's close at $1,376 while silver is off by a stunning $2.30 to $23.55 per ounce - a drop of about nine percent this morning. Most base metals are trading close to unchanged with the exception of copper which is down by nine cents to a multi-month low at about $3.26 per pound. Mining share indexes are sharply lower.
In other markets, long-term interest rates are trading close to unchanged; Crude Oil is down by about $2.50 per barrel and now sits under the $90 mark and the US Dollar Index is trading five basis points lower at 82.36.
All quotes US$ unless otherwise noted.
Next "Melman Minute" scheduled for Wednesday, April 17, 2013