Gold and Silver At A Crossroads

Both gold and silver are at crossroads

Many investors are studying the charts. Bolstered by the recent price movements, they envision positive returns once the upside barriers are broken. Such an action would seemingly prove that new foundations were built and new uptrends are in place. Gold and silver then should be able to move up to the next barriers and, perhaps, even to new highs.

The upside problem: Fewer fundamental supports

Strongly held fundamental beliefs created the long price uptrend, but they are now weakening. These fundamentals have been forecasts of reversal or calamity, against which the metals would provide protection.

Using the Great Recession events and data, a common expectation was high (hyper) inflation from ballooning money supply, linked to government deficits with a prolonged stagnant economy (sometimes tied to the end of consumerism). Also common were the mega-fears, with visions of global economic and financial crisis or collapse. Finally, there was the view that the only way to regain order was to restore hard money to replace worthless fiat currency.

Today, however, those basic underpinnings are weakening because conditions are getting noticeably better. Since late 2011, there has been a steady stream of positive economic reports. The U.S. dollar has maintained its exchange rate and global reserve position. Stock investors have shaken off their mega-fears, and the market has been rising steadily. There is no sign of rapid inflation or an attendant ramp up in interest rates. Even government revenues are improving.

The downside risk: A return to inflation protection only

Deteriorating fundamental support means the chart readers’ expectations are too optimistic. With the return to economic and financial normality, not only will investor interest in gold and silver dissipate (nothing to protect against), but also the metals’ price supports will shrink to the long-standing one: Inflation protection.

And that’s why the risk is large. Today’s gold and silver prices are far above their inflation protection value. How far? After gold’s similar peak in 1980, it fell 80%. Based on my previous analyses (listed here), gold’s price based on inflation protection fundamentals could be as low as $570, 68% below today’s price of $1,773.

The bottom line

Gold and silver prices are at a crossroads. The chart pattern of a reversed downside breakout followed by a rise to an upside barrier carries the hope that a foundation has been built upon which a new uptrend is in place.

However, the fundamental underpinnings for gold and silver prices are disappearing, meaning the price foundation is returning to its root determinant: Inflation protection. The problem is that the inflation-based values, using historical analysis, are much lower than today’s prices.

Therefore, the crossroads can be viewed as either:

  • A slow upward rise, as the metals break their current high barriers and work to recapture lost ground by rekindling investor interest
  • A reversal and downside breakdown, confirming the 2011 tops as speculative blow-offs and setting the stage for a large, prolonged downtrend

My belief is that the risk isn’t worth the possible return and, moreover, that the probability of a reversal outweighs the possibility of a continued rise.

via Gold, Silver At A Crossroads: Opportunity For Gains Or Risk Of Extended Decline? – Seeking Alpha.

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