The Coin Analyst: Precious Metal Bulls May Need to Rethink Their Position

By Louis Golino for CoinWeek ………

As the end of the first year in two decades in which gold prices are down for the year to the tune of 29%, it is a good time to review the outlook for precious metals and whether it is time to rethink one’s perspective. After all, if one is not open to changing one’s mind, one is not really thinking in the first place. Overall, the very strong equity market, whose average return is about 25% for the year, is pulling investors away from metals and into stocks. In reality, the two are of course not really in competition both because the stock market dwarfs the metal markets and since smart investors have some money in both areas. The manner in which the two assets are interposed in the financial media, as if one somehow is supposed to choose between them, is highly misleading. Besides, it would be foolish to invest the majority of one’s assets in precious metals, whose prices are always very volatile, especially if you need access to some of those funds.

I agree with the view that gold and other precious metals in bullion form should be used mostly as an insurance policy and a long-term investment that should provide protection against a combination of high inflation, currency depreciation, and economic crises. If you are investing a large amount of your portfolio in metals, it should also be diversified into numismatic coins and perhaps mining company stocks, if you do your research, and of course hold other types of assets too like real estate, or you will regret putting too many eggs in the same basket.

There is simply no way to escape the fact that there is a huge gap between the performance of precious metals in 2013 and stocks, virtually all of which are sharply up for the year. As a friend of mine who invests in stocks said recently of the past year, “You could throw a dart at a stock, and it went up.” This gap may or may not turn out to be a long-term trend, but it is one that deserves attention. One can easily counter that no asset is always up, that gold has seen an amazing run so far, and so forth. But metal bulls need to do some soul searching after two bad years.

There is always a danger in drawing too many conclusions from relatively short-term trends, and the long-term fundamentals for metals are probably still quite strong. Not to mention that for the past five years gold is still up 53%, and for the past 10 years it is up a whopping 213%.

But with higher inflation not having materialized after several years of the Federal Reserve’s trillions of dollars of bond buying, known as quantitative easing, and with little likelihood of higher inflation for at least several years and even then perhaps not that much, as well as relative stability in the U.S. and global economies, it is unclear where metals are headed in the short-term. I doubt we will see prices below $1100, and there does seem to be support in the low $1200’s. But as for the upside, I honestly have no idea.

Silver prices, which continue to hover at the $20 mark, have done even worse than gold and continue to seem like a bargain to me. Platinum and palladium seem like they should do better in an expanding economy, but gold has a tendency to bring the other metals along with it in both directions.

QE has clearly helped support both higher stock and higher metal prices, as it encourages investors to put more money into riskier asset classes. But an important recent development is that the Fed’s message that QE is unlikely to begin to change probably until next spring, if not later, has been pushing stocks higher and metals lower, whereas in the past that would have pushed both higher. Interest rates have been rising in recent months, but that has so far failed to have much impact on equities.

An important clue may come from the fact that John Paulson, one of the world’s biggest and most bullish gold investors, recently told investor’s in his gold funds that he would not recommend putting new money into gold now. This is the first time to my knowledge that he has made such a recommendation at least in the past few years.

Such advice flies in the face of the unchanged bullishness of people like my colleague Patrick Heller, who has written extensively about precious metals, and who recently wondered if we will see $3,000 gold by 2015 (http://numismaster.com/ta/numis/Article.jsp ad=article&ArticleId=27435&et_mid=649969&rid=238119428).

Mr. Heller writes frequently about how he believes the price of gold is manipulated because the U.S. government does not like higher gold prices.

My own view is that some kind of collusion may well exist between the major banks involved in the metals trade and large metal sellers, but I do not see any governmental role in this. One is tempted to say that if the government could do that, how come it had so much trouble launching the health exchanges?

In any event, it is noteworthy that the London fix as it is called, which is an almost hundred year old daily event when five megabanks meet to set the price of gold, has recently started to come under scrutiny by British legal authorities. They are investigating whether information shared during the calls between banks could give unfair advantages to buyers and sellers of the metal, as explained recently in Bloomberg Business Week .

The London fix is a benchmark rate used for buying and selling gold, and is in fact one of the key factors used by the U.S. Mint when it adjusts prices every Wednesday for its gold numismatic products. As Bloomberg explains, the traders involved in this process briefly have access to information other people in the metals trade do not have, which is a major flaw.

Whatever the outcome of the British investigation, it seems reasonable to postulate that the gold market does appear to be rigged in the banks favor, as seems to be the case in other areas. But that is not likely to change, and it would seem we are basically stuck with the system we have.

I am by no means recommending that metal investors sell at current levels, and I think we are at good buying levels especially for silver, which would seem to have little downside risk at current prices.

But the die-hard gold bulls that constantly predict prices several multiples of today’s levels either soon, or in a couple years, could simply be wrong. Prices may grind higher in the coming years, and probably will, but I think it is time to reel in some of the excessive enthusiasm and the constant talk of sharply higher prices around the corner.

Even in the event of an economic calamity, as we saw in 2008, buyers sell precious metals to raise money, though that will change if the dollar continues to lose purchasing power, or if investors come to doubt the full faith and credit of the United States. The real issue is whether governments will be able to keep inflation in check as growth grinds higher and interest rates too, and at this point it is at least worth entertaining the possibility that they will be able to do so at least for some time.

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.