Gold, silver now building big technical bases

As 2014 continues to unfold, both gold and silver are starting to perform impressively.

Both metals appear to have made major bottoms following gold’s plunge to US$1,180 an ounce at the end of 2013 and silver’s dip to US$19 an ounce and change.

In fact, gold and silver have been building big technical bases — bases that should be more than enough to propel them to all-time highs over the next 12-18 months.

As I’ve noted before, both metals were attacked by western governments, their central banks, the Bank of International Settlements, along with a group of allied bullion banks, all acting in unison.

Indeed, it was no accident that gold came under heavy pressure after hitting an all-time high of US$1,900 an ounce in August 2011, following Standard & Poor’s downgrade of U.S. government debt.

At that point, the Obama administration realized gold was a major threat to the U.S. dollar and, by extension, to its coveted position as the world’s reserve currency.

So, Washington set out to destroy gold’s appeal using the most blatantly manipulative tactics ever seen in the ongoing gold wars.

The metal was attacked in the paper markets with derivatives, algorithmic programs, naked shorting, as well as with other arcane techniques.

And for all intents and purposes, the attack succeeded as western investors abandoned precious metals, pulling down gold and silver prices at they raced for the exits.

Demand underestimated

But there was one major flaw in this well-thought-out plan. The powers that be in the West sharply underestimated China’s hunger for gold, as well as Russia’s.

In fact, neither the Chinese nor the Russians had any interest in so-called paper gold. They wanted the real thing.

And they were delighted to be able to buy it in large quantities at bargain-basement prices — prices that had been established in the fraudulent paper market.

In 2013, says the China Gold Assc., Chinese consumers alone bought 1,176.4 metric tonnes of the yellow metal — a 41 per cent increase over the previous year.

This represents nearly half of all gold mined outside China and Russia, neither of which now export any of their output.

Yet, this number excludes gold imported by the two governments and their central banks, such amounts usually being disclosed well after the actual purchase.

With other significant gold buying going on in Russia, the Mideast and India, it was clear an enormous above-ground inventory had to be mobilized — and it most assuredly was.

Hundreds of tonnes poured out of exchange-traded funds, while huge quantities clandestinely came onto the market from the West’s central banks.

But this supply isn’t endless. Unlike the paper market where the same ounce of gold is sold over and over again, gold sold on the physical market disappears into buyers’ vaults, there to remain — if it ever does re-emerge — until prices go dramatically higher.

This whole process seems ludicrous, given the existence of sharply lower prices at a time of exploding physical demand — a demand that overwhelmed normal channels of supply.

Yet, desperate men do desperate things. And the powers that be in the West are nothing if not desperate as their economies languish and their debts continue to spiral.

The only thing that’s kept the West from almost certain economic implosion are zero-based interest rates and the seemingly illimitable printing of money.

Now, the U.S. Federal Reserve is tapering off, reducing the amount of money it prints every month to roughly US$65 billion from $85 billion.

To date, the Fed’s move has had only minimal impact on the U.S. But the emerging market countries, such as Argentina, Turkey and South Africa, have seen both their currencies and markets take a severe beating.

Very simply, America’s financial profligacy since the crash of 2007-’08 has washed over the globe, creating mini-bubbles almost everywhere.

Negative impact now being felt

But now, as the U.S. tries to rein things in, the negative impact, or the unintended consequences, are being felt in many places.

So the big question remains: will western countries try to follow through with their plan to be more financially disciplined — a move that will most likely trigger some form of economic collapse?

Of, will they quickly revert to printing whatever money is needed to keep themselves afloat?

I’m betting on the latter — a situation in which hyperinflation will become a big issue.

Many economists who focus on micro issues can’t image hyperinflation.

They reason that because the economy is now so weak, demand isn’t strong enough to generate inflation, let alone, hyperinflation. But this ignores the fact that hyperinflation is purely a currency event.

To counteract the weak economy, as well as the corresponding deflationary impact on a financial system that’s now extremely vulnerable, the authorities simply print more money.

Indeed, they keep on doing so until the velocity of money explodes, currencies collapse and prices for all things denominated in the debased currency skyrocket.

In the meantime, when it comes to the economy itself, Western governments, along with their apologists in the mainstream media, have been guilty of a con job.

They’ve been trying to convince us that we have a nascent recovery — one that’s not only on the verge of becoming robust, but self-sustaining to boot.

In their minds, no matter how bad things are in Japan, Greece and Spain, better days are right around the corner.

But I believe they’re dead wrong. I say so because I’m a great believer in Austrian economics.

That school holds that as a credit cycle matures, it takes more and more credit creation to generate the same dollar of real growth in gross domestic product.

We’re already very deep in this credit cycle. In fact, the world has never seen leverage remotely approaching current levels.

Levels at all-time high

And this leverage is only amplified by the hundreds of trillions of dollars in derivatives now sloshing around the global banking system.

Simply put, the amount of credit creation that’s needed to generate any real economic growth in the West has become untenable.

Indeed, we can’t even come close to servicing the debt we’ve already accumulated.

Japan is poster boy

The poster boy here is Japan — a once powerful country, now burdened by an aging, shrinking, xenophobic population.

Not only has Japan been fighting deflation for nearly 25 years, it has by far the highest embedded ratio of government debt to GDP in the industrialized world.

Shinzo Abe, Japan’s seriously misguided prime minister, actually thinks he can blast his way out of this predicament by combining aggressive fiscal stimulus with outrageous money creation.

But, I fear, he’s leading his country down the path of currency destruction and hyperinflation.

Moreover, this is now a worldwide phenomenon with insoluble debt problems having boiled up virtually almost everywhere.

The wild card remains China which has been a growth engine for several decades, moving its rural population to urban factories, while running up a massive debt paying for world-class infrastructure and an export juggernaut.

But now that China has weighed itself down by both overcapacity and a big debt, there’s hope it can make a smooth transition from an export economy to one based on consumer spending.

Although this will ultimately happen, the odds are the move won’t be smooth, given a world now plagued by economic weakness. What all this ensures, I suspect, is an ongoing blizzard of global liquidity.

Potential is apparent

And with both gold and silver now significantly undervalued, the potential for huge upward price jumps should be apparent to anyone with an open mind.

But the real upside potential continues to lie in the shares of gold and silver producers themselves.

They’ve been beaten down to levels seldom seen. And the total capitalization of all the world’s gold stocks is roughly US$300 billion.

This qualifies as less than a rounding error in the modern financial world.

And when capital, responding to higher gold prices, seeks exposure to precious metals miners, the impact on gold and silver stocks will be something to behold.


– John Embry is chief market strategist at Sprott Asset Management in Toronto.


Investor’s Digest of Canada, MPL Communications Inc.
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