Precious Metals Were In Correction Mode

by: Andrew Hecht

- The dollar relationship is a mirage.

- Gold lower than recent highs but strong.

- Silver lower than recent highs but very strong.

- Platinum and palladium show signs of life.

- Higher highs and higher lows on the horizon.

Last week we heard from the U.S. Federal Reserve Open Market Committee, and there was no surprise in their action or lack thereof. The FOMC voted to leave interest rates unchanged while issuing a statement pointing to moderate growth in the U.S. economy, an improving labor market, and citing gains in payrolls in the June report. All of the data inputs needed for an increase in the Fed Funds rate appeared to be present as the committee met in July but the central bank decided to leave rates unchanged.

In December 2015, the Fed hiked interest rates for the first time in nine years and promised 3-4 more hikes in 2016. With seven months behind us, they have not kept their promise. The Fed has vacillated between excuses and promises over the first seven meetings of 2016, and the July meeting left markets with yet another promise. Some analysts now expect a rate rise at the September or December meeting, but in my view, they are dreaming. The U.S. Presidential election will supply the next series of excuses for the central banks to leave rates unchanged and at the current artificially low level.

Precious metals have been the only accurate reflection of central bank policies in the United States and around the world.

The dollar relationship is a mirage

Last week, as markets prepared for the latest interest rate decision from the Fed, precious metal prices moved lower from highs seen after the surprising results of the Brexit vote. When news of another month of no change in monetary policy hit the markets, precious metals rallied sharply. The move in the dollar index was mild. Then Friday the dollar moved lower perhaps more due to disappointing action from the Bank of Japan.

As the daily chart of the dollar index highlights, the index peaked at 97.62 on the September futures contract on July 25 and fell to 96.721 by the close of business last Thursday, the day following the latest Fed announcement. The greenback fell to lows of 95.335 last Friday and the greenback put in a bearish key-reversal trading pattern on the weekly chart on low volume.

The dollar made a marginal new high on the week and then closed below the prior week's lows.

Despite the bearish reversal, the dollar continues to trade close to the highs of the trading range since May 2014, the action in precious metals gives reason to pause. Since late 2015 and early 2016, the prices of all of the major precious metals traded on futures exchanges have rallied in dollar terms. In fact, gold, silver, platinum and palladium have moved higher in all currency terms over recent months. Precious metals are making an important statement on the value proposition for all currencies. These shiny metals are telling us that the value of all paper foreign exchange instruments has moved lower. The "strong dollar" is only strong when compared to other paper currencies, compared to precious metals the dollar has weakened. Therefore, the argument for a high dollar has been more myth than reality.

Gold lower than recent highs but strong

Gold moved to highs of $1377.50 in July following the Brexit surprise and since then has corrected lower reaching a recent bottom of $1310.70 before the latest Fed missive.

Meanwhile, the monthly chart of COMEX gold futures illustrates that the momentum of the yellow metal is still bullish and with substantial volume and open interest. The increase in volume and number of long and short positions in COMEX gold futures provides technical support for more price appreciation. While it is possible that gold could correct lower, key support is now far below current prices. The 50% retracement level of the move from $1046.20 in December of 2015 to the recent highs is at $1211.85 per ounce. Therefore, a move back to $1280 or $1250 would not reverse the bullish market trend for gold. Resistance is now at the March 2015 highs of $1392.60 per ounce and the August 2013 highs of $1428, which is my initial upside target for the yellow metal.

Gold closed last Friday at the $1358 level, over $300 or almost 30% above the December 2015 lows.

As a side note, gold put in a bullish key-reversal trading pattern on the daily chart last Friday on moderate volume.

While gold remains firmly in a bullish trend, the performance of silver has been even more exciting over recent weeks.

Silver lower than recent highs but very strong

Silver reached lows of $13.635 per ounce last December. In July, the price of gold's little brother peaked at $21.095, an increase of almost 55%.

The extraordinary move in silver came as a delayed reaction to the move in gold. Silver had taken its time before it exploded higher starting in April. The monthly chart of COMEX silver futures highlights significant bullish momentum. Large volume and rising open interest validate the move from a technical perspective. In fact, open interest has increased to all-time highs, an indication that the action in silver is attracting new market participants.

The value proposition for silver may be more bullish than the price trend itself. The price volatility in the silver-gold ratio demonstrates the strength of silver compared to gold over recent weeks.


The monthly pictorial of the silver-gold ratio shows that it traded to the highest level since 1995 in March of 2016 when it reached over 83:1. Since then, the ratio has dropped to 66.3:1 or 66.3 ounces of silver value in each ounce of gold value. The long-term average for this price relationship is 55:1 however it tends to deviate from that mean level over time. Over the course of history, during bear market periods in the precious metals sector the ratio tends to move higher and during bull market periods it tends to move lower. The move since in this inter-commodity spread over recent months is further confirmation of the bull market in precious metals.

Support for silver is at the 50% retracement level of the move from the December lows to recent highs and stands at the $17.365. Silver closed last Friday at the $20.38 level on the September futures contract. At this point, the precious metal could withstand a severe selloff and still be in a long-term bullish trend. However, my initial upside target for silver is the August 2013 highs at $25.12 per ounce. A gold price of $1,358 would imply silver at $24.70 if the silver-gold ratio were to return to its historical norm.

The other two precious metals that trade on futures exchanges also have displayed signs of life over recent weeks.

Platinum and palladium show signs of life

Platinum and palladium are both industrial and precious metals. They each have a myriad of applications in industry, but each is rare and has a history of investment and speculative interest. Given the weakness in the global economy, platinum and palladium had remained at depressed levels but recently, they have rebounded dramatically along with gold and silver, their precious cousins. 

The monthly chart of NYMEX palladium futures shows the rally from $451.50 at the beginning of 2016 to highs of $715.90 last week, an increase of over 58.5%. Momentum on the price of palladium is currently higher while open interest is rising and relative strength is climbing over recent weeks. While palladium has outperformed on a percentage basis, the action in platinum, a more actively traded precious metal, is even more compelling for the sector.

NYMEX platinum futures have appreciated from lows of $812.10 in January 2016 to highs of $1,163.80 last week. The increase of over 43% has created positive momentum for the precious metal, and open interest has grown to an all-time high. The value proposition for platinum versus gold has also improved over recent weeks. The long-term (40-year) average for the price differential between platinum and gold has been around a $200 premium for platinum over the yellow metal. That is why platinum often has the nickname "rich man's gold." However, since late 2014, platinum has traded at a discount to the price of gold. That discount reached an all-time low of around $350 per ounce at the end of June of 2016. Since then platinum has outperformed gold.


As the daily chart of the price of platinum minus the price of gold illustrates, the spread has moved from over a $350 discount to around a $200 discount over the past month. Platinum remains around $400 below its long-term average level versus gold. During bear markets in precious metals the discount of platinum under gold tends to increase and during bull markets platinum tends to outperform gold. In 2008, when both platinum and gold broke to new all-time highs, platinum traded at over a $1,200 per ounce premium to the price of gold.

Platinum closed last Friday at $1,154 per ounce, with gold at $1,358 a return to the long-term norm in the spread would put platinum at $1,558 per ounce. Technical resistance for platinum on the monthly chart is at $1,289 and $1,514. The 50% retracement level for platinum and palladium are at $986 and $580, respectively. Both metals are significantly above their critical support levels, but both have room for corrections.

Higher highs and higher lows on the horizon

Markets never move in a straight line. There is often a tremendous amount of volatility in even the strongest bull markets. I believe that all evidence points to an important bull market in the four major precious metals that may only be in its very early stages.

The price moves and momentum in all four metals compliment increasing open interest and volume in the futures as well as the ETF and ETN markets providing technical validation for the price appreciation. Additionally, fundamentals may have never been better for the precious metals sector.

Fear and uncertainty in the global economic and political landscapes continue to provide the rationale for higher prices. Investment demand for precious metals continues to increase.

In May of this year, the Swiss exported a record amount of gold to the United States. The Swiss shipments totaled 20.7 metric tons, more than 50 times the average monthly exports and an amount that is more than the total gross exports for all months dating back to 2000. With record levels of open interest in the silver and platinum futures markets and the inter-commodity price relationships between gold and its precious cousins moving in a direction that implies a bull market, precious metals are flashing ominous signs. The conventional wisdom is that precious metals increase in value during inflationary periods in history. The rallies in these four metals may just be a significant harbinger of a future inflationary spiral, the result of years of central bank accommodation.

I believe that precious metals will rise to levels that many analysts have not ever considered, over the years to come. However, the road will be bumpy, and the opportunity to buy on dips will allow investors and traders to hop on board the precious metals freight train that is a long way from its final destination.

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