by Louis Golino for CoinWeek
This is the second part of my year-end review and outlook for the coming year. The first part addressed the numismatic market. This one covers precious metals.
2011 has been a roller coaster of a year for precious metals. This article only addresses gold and silver, but it is also worth keeping an eye on platinum, which I believe is undervalued at today’s $1400 level.
Silver came very close to reaching its 1980 price of $50 per ounce in late April, but has declined 40% to $29 since then.
Gold hit an all-time high of $1920 on September 6*, but since then its price has usually been in the $1600-1700 range, and many analysts believe even lower prices are coming.
As of now, for the year gold is up 12%, while silver is down about 5%, and equities are basically flat for the year. Despite all the sound and fury about gold being a bubble that has burst, it continues to be the best-performing asset class, as it has for the past decade.
A lot of the recent price decline in gold is due to dollar strengthening, as investors seek the perceived safety of U.S. Treasuries at a time when the European crisis seems to loom larger every day. To help put things in perspective, in euros the price of gold is only 100 euros off its all time nominal high reached in September (1300 to 1200).
For the year that is finishing, the key questions in the precious metals realm are: Why did gold decline sharply after hitting its all-time high in August? Second, why is gold apparently no longer viewed by many investors as a safe haven asset? For silver, why did it fail to surpass $50 this past spring and decline by 40% since then?
Looking foward, for the coming year, the main questions are: Where is gold’s price headed? Is it moving towards $1500 or less as the bears predict, or will it reach new highs in 2012? And will silver continue to hover where it is now, or even decline to $20, especially if the economic recovery falters? Or will it hit new high well above $50, as silver bulls predict?
A series of macro-economic factors will help shape precious metal markets in 2012, including: the European debt and banking crisis and the possibility of European quantitative easing, what happens to the U.S. economy, the value of the dollar; and prospects for further quantitative easing in the U.S. Each of these factors is intertwined with the others.
Some analysts have begun to speculate that either the European Central Bank, or the Italian government, might liquidate some its gold to raise funds to increase liquidity, especially if the bond vigilantes continue to try to raise the cost of borrowing for Italy to unsustainable levels (over 7%). Italy will need to refinance many billions in government debt in 2012.
Italy currently has the fourth largest gold reserves in the world.
While I would not rule out the possibility of Italy selling some of its gold, I believe it is more likely that we will see increased buying of gold by central banks for asset diversification.
China, despite all the headlines indicating it is buying and mining precious metals as fast as it can, continues to hold all but 2% of its foreign reserves in dollars, as noted recently by Brent Arends in http://www.marketwatch.com. If the world continues to lose faith in the long-term prospects for the dollar, China is virtually certain to shift more its foreign reserves into gold.
A senior Chinese central bank official made just this recommendation the day after Christmas. That would be a major market mover for the price of gold.
Other countries’ central banks, including those in India, Russia, and Malaysia, have added to their gold holdings this year.
In 2012 the ongoing European debt and banking crisis is likely to put pressure on the price of gold, which may seem counter-intuitive. But as I explained in the fall, gold’s role is changing.
What has changed in gold this year is that it is now seen as a risk asset, like equities, rather than a safe haven to flock to when riskier assets are down.
But the long-term fundamentals, most analysts agree, remain very bullish, especially since governments around the world lack effective tools for dealing with the economic crisis and are likely to continue using the main tool left: currency devaluation, which reduces the value of a country’s debt, but also raises the prospects for future inflation.
Moreover, supplies continue to be constrained by the cost and difficulty of finding new deposits, and demand is strong, especially in Asia.
In the short-term, European economic troubles could result in more selling pressure on gold, but 2012 is expected to be (finally) the year of reckoning for Europe. The European Central Bank is likely to be forced to print money (quantitative easing) to monetize the debt of European countries, and this should eventually push gold over $2,000.
For silver, a different set of dynamics will play out.
Continued economic slowdown would clearly put a damper on silver prices, but silver is a hybrid metal, both industrial and precious. If the gold market reaches new and sustained highs, it is likely to bring silver along with it.
A major wild card is possible resolution of what Kitco has called “The Great Silver Debate.” That is a reference to the idea that silver prices are manipulated by the U.S. government working with large banks involved in the metals trade to suppress prices through techniques such as frequent margin hikes.
Silver bulls believe firmly that a day of reckoning is arriving in which the true extent of silver shortages will be revealed, but it is hard to say when that will happen.
Silver did not decline by 40% since late April because demand for it declined. In fact, demand for silver remains very strong, as seen in the record-number of American silver eagles sold this year and tight supplies at silver bullion dealers.
It is the disconnect between the physical and paper markets; repeated margin increases; and the need to cover losses in other trades that explain silver’s decline. In particular, paper silver speculators got spooked by silver’s wild ride after April, while large institutions have had to sell metals to raise capital. But long-term physical investors have continued to take advantage of low prices to add to their holdings.
According to Paul Tracy of http://www.seekingalpha.com, 25% more silver is consumed than mined every day. Even if one accounts for silver recycling, the shortage of silver in the world should eventually drive silver a lot higher, probably well over $100 per ounce.
Silver also seems very undervalued now since according to Mr. Tracy, silver is 17 times more abundant than gold, but one can buy 54 ounces of silver for an ounce of gold.
Lessons of 2011
Overall, I remain bullish on precious metals for the long-term based on the fundamentals of supply and demand. But we also were reminded in 2011 how imperfect the precious metals market is, and how much it is shaped by macro-economic factors, regulatory regimes, and the performance of other asset markets.
So it would be prudent not to assume that there will be a direct correlation between global economic turmoil and the price of gold and silver, in which investors flock to metals for safety. We have learned that things are more complicated than that.
Happy New Year to CoinWeek readers!
*In my December 23 article on the coin market, I said gold hit an all-time high of $1906 on August 22. This was based on a chart I found at Kitco, but the correct date and figure are $1920 on September 6.
Louis Golino is a coin collector and numismatic writer, whose articles on coins have appeared in Coin World, Numismatic News, and a number of different coin web sites. 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.