The Coin Analyst: Forces Shaping Precious Metals in 2014

By Louis Golino for CoinWeek ………

After the worst year in three decades for gold and silver prices, the outlook for precious metals is currently a subject of even greater interest than usual to investors.  I believe 2014 will be a critical year for the metal markets, a possible turning point, leading either towards a consolidation of last year’s bear market, or pushing ahead and laying the foundation for eventual new highs in the coming years.

At the beginning of 2013 the conventional wisdom was that after cooling of a little in 2013 after its all-time highs in 2011, gold would surge toward new highs, with some analysts throwing out numbers like $5,000.  But unlike other areas of financial and economic interest, with gold, people can throw around extremely high or low numbers with little consequence, as there is little concrete evidence to back up such predictions.

The situation is further clouded by the fact that metal bears rarely even bother to try making strong arguments.  They just continue to hammer on about the negative outlook for high precious metal prices, frequently pointing to the three-decade trend of moderate inflation to provide some semblance of support for their contentions.

And yet metal bulls, the ones who are vested enough in the field to take the issues seriously, are too often biased cheerleaders, who seem to think higher prices are always around the corner.  This situation makes it hard to find solid, unbiased analysis on the outlook for precious metals, and providing that is one goal of this column.  I do consider myself a long-term bull, but I try to present as fair an analysis as I can, and if I think the outlook is negative, I will and have said so.

As I suggested last month (https://coinweek.com/bullion-report/coin-analyst-precious-metal-bulls-may-need-rethink-position/), metal bulls need to come to terms with why they were so wrong in the past year, and specifically, with the fact that quantitative easing (QE) and high global growth rates are simply not guaranteed to lead inexorably to significantly higher inflation, let alone to hyperinflation, as so many gold enthusiasts predict.  The key area where they went wrong is in believing that QE will never end or be reduced, though at the moment we are only at the beginning of the move to reduce QE.

Far too many bullish analysts remain confident in their argument that it is not possible to inject so many trillions of dollars into an economy without it eventually producing massive inflation, but as I have explained before, economic theory does not support that argument.  In order to have an inflationary impact all that money created by the Fed would need to really circulate in the economy, not to sit on bank balance sheets, and one would also need to see rising labor inflation, meaning the average worker getting substantial pay raises, and that has not been happening either.

Of course, eventually the money created by the Fed will circulate as economic conditions improve, and someday American workers will be in a position to demand higher wages, but it is quite possible, probably even likely, that the Fed would have moved by then to end QE and to raise interest rates enough to stave off higher inflation.  If it can do so by just the right amount and not choke off economic growth, the economy should continue to percolate without overheating.  The wild card is that nothing on the scale of the QE rounds of the last couple years has ever been done, and there have been instances in the past when the Fed moved too slowly to either tighten or loosen monetary policy.

The conventional wisdom is usually wrong, and I think that 2014 will be at least a moderately positive year for gold and other precious metals, especially for silver, which has the best potential for upside and the least downside risk at its current level of $20 an ounce.  Platinum and palladium should also do well as the economy continues to expand.

The five key factors that should push prices for precious metals higher this year include:

Central bank gold buying, including in particular the forthcoming announcement that China’s central bank added significantly to its official reserves, according to gold analyst, Jeffrey Nichols, which will surely provide the catalyst for higher prices when the news goes mainstream.  According to his web site (www.nicholsongold.com): “The PBOC reported in April 2009 that its official gold reserves stood at 1,054 tons – and it has not reported any increase in official gold reserves since that announcement nearly five years ago.  Now, it seems, we will soon learn it bought a total of 654 tons in 2009 through 2011, another 388 tons in 2012, and more than 622 tons last year.  Much of this has come from domestic mine production and secondary supply.”  These additions to China’s gold reserves would make it the 4^th largest gold reserve holder in the world with 2,710 tons of gold as of the end of 2013 according to Nichols, if confirmed by the Chinese government.  However, some analysts doubt that these announcements are coming, so we will have to see what happens.

Concerns about the outlook for equities, which are unlikely to match their performance of last year, especially as the Fed moves to reign in QE, and with many analysts also cautious about company earnings.   Gold has been struggling to go over $1250 since the start of the year, and silver to go over $20, and each time it has begun to do that, solid gains in the equity markets have pushed metal prices back down.  This means that in the coming year gold should continue to play its traditional role as an asset that usually moves in the opposite direction as stocks.  If equities outperform like last year, investors will pay less attention to opportunities in precious metals.

Supply constraints, which should become more common and significant as they year goes on, especially if prices remain low early in the year.  It is simply not economically feasible to mine gold or silver at current prices, and many mines are closing as a result, which will eventually squeeze supply.  Initially, this issue will probably be more important for silver prices because silver supplies are reduced every year through industrial applications, while gold prices may respond more slowly to supply reductions.

Growing focus on the issue of government manipulation of precious metal prices, with the latest proponent of this argument being a respected official of Germany’s leading financial regulator, Elke Koenig, who heads Bafin, may also exert upward pressure on precious metal prices.  Koenig recently told Bloomberg that the rigging of the metal markets is worse than the Libor scandal regarding the fixing of interbank lending rates (http://www.bloomberg.com/news/2014-01-16/metals-currency-rigging-worse-than-libor-bafin-s-koenig-says.html).

Growing demand in Asia from individual investors, and the easing of import restrictions in India.  Demand in the west was more uneven in the past year, as lower prices scared off many large and institutional investors, and demand from smaller investors is not significant enough to have that much impact on prices.  If metal prices move substantially higher over the course of the year, larger investors in Western countries will likely become more bullish and make purchases that will create more upward momentum on prices.

Louis Golino is a coin collector and numismatic writer, whose articles on coins have appeared in Coin World, Numismatic News, a number of different coin web sites in addition to being a contributor to “American Hard Assets magazine”. His column for CoinWeek, “The Coin Analyst,” covers U.S. and world coins and precious metals. He collects U.S. and European coins and is a member of the ANA, PCGS, NGC, and CAC. He has also worked for the U.S. Library of Congress and has been a syndicated columnist and news analyst on international affairs for a wide variety of newspapers and web sites.