Gold, Silver and Stocks: What does the New Year Hold?

Do precious metal prices reflect economic fundamentals or perceptions of price trend prospects? Silver sells around $30 an ounce and is near a 30-year high. Gold sells for more than $1,400 an ounce. Can gold and silver double from here, with silver already selling for more than five times typical producer costs? (Yes, the prices can double, but not likely.) Just what were J.P. Morgan analysts thinking in June 2010 when, with silver around $18 an ounce, they gave a long-term silver price forecast of $13 an ounce? Were they trying to turn the market? Or did they misunderstand the times?

One recent driver of precious metals demand has been the aggressive de-hedging activity of big mining companies. (See “Gold hedges rise 2% in second quarter, September 29, Marketwatch.) With de-hedging by big companies poised to ease in 2011 (the commercial gold hedge book is now down over 90% from its year 2000 peak), more demand from investors will be required to maintain bid side pressure. Granted, junior precious metals companies have been adding hedges to get bank financing for new mine projects.

There is a growing market rumor that some mining company executives are concerned about price sustainability at these levels. If trend momentum stalls and a few big-time mine executives decide to lock in high prices on forward production, the reversal of hedging activity could undercut precious metals market psychology.

Another potential problem for gold bulls is that hedge funds and their Wall Street bankers took positions opposite the mining companies in the hedge books — positions that have cost mining companies many billions of dollars of lost profit since 2005. Interestingly, the banks opposite the commercial hedges (perhaps not J.P. Morgan) wanted higher precious metals prices so that they could flip the gold internationally for greater profits as mining companies de-hedged. Now that commercial gold hedges will be substantially reduced by early 2011, the contra-hedging segment of Wall Street that had a vested interest in higher gold prices will no longer retain that interest. For the general public this means “beware”: The Wall Street majority may want precious metals prices to go the other way starting sometime in 2011. Lower metals prices could mean lucrative opportunities for Wall Street elites to buy out miners and take over their resources in the ground.

Allegedly, gold and silver prices will continue rising because the dollar will weaken as the Fed continues to print money in the context of extended Bush era tax cuts. (This is the number one argument for higher gold prices.) But what will happen if the orchestrators of investor psychology announce that precious metals have already priced in dollar weakness for the next several years? After all, the U.S. dollar has been fairly robust during the last three years while the money printing machine went crazy — a period when gold and silver behaved as though the dollar was being decimated.

Factors That Impact Pricing

These matters can get confusing. It helps to consider that gold and silver during the last couple years have been pricing speculative dollar sentiment, not the value of the dollar in relationship to foreign currencies that were also suffering debasement by monetary inflation. The two-sided currency debasement — U.S. dollar v. foreign currencies — cancelled out, leaving gold and silver artificially elevated (on the currency metric) in all developed countries. But there are other metrics as well: Sovereign debt risks, the de-legitimization of the democratic process as constructed, bank balance sheet weakness in the light of demographic fundamentals like population aging, and the decline of the middle class in developed countries. In light of these factors — non-currency considerations — gold and silver prices may trend considerably higher. Nevertheless, if an important pillar of the rationale for higher prices (i.e., dollar weakness) gets revealed as disconnected from reality, the pricing structure could cave in. This hazard is especially noteworthy now that de-hedging is nearing completion and the powerful interests opposite the former hedgers no longer have an incentive to drive prices higher as they did during the 2006-2010 period of de-hedging.

Everyone wants price targets. But how high precious metals prices may go cannot be predicted. It's like the issue of economic autonomy — it works until it doesn’t work. The gold price trend could die in January 2011 or hang on until after the November 2012 presidential election. Fundamentally, precious metals pricing is already ballooned. But popping the thick-walled balloon may take the coalescence of multiple factors. Many rationales for higher prices have been piled on top of an abiding fear that government can no longer be trusted. Remember, if gold doubles in value from here it will take a mere handful of gold coins to buy an above average house in most parts of the country. At some point people will prefer the nice paid-for home instead of the gold...and the price of the yellow metal will descend to earth.

Gold bulls need to consider that China’s money supply has been growing rapidly and Europe will need to bail out at least a couple more countries. These dynamics could keep the U.S. dollar stronger than most Americans expect, even in the face of continued quantitative easing by the Fed. It looks increasingly likely that the central bankers’ plan is not to trash the value of the dollar but to trash the dollar’s viability as the world’s reserve currency. If so, precious metals may have priced in an outcome that will not materialize (i.e., a much weaker dollar). Still, as previously argued, bull trends can be self-reinforcing price discovery malfunctions; they can persist, lacking a proper regulatory environment, from their own inertia. Currently, U.S. capital gains tax code subsidizes precious metals speculation while ETFs give the public liquidity and ease of access. This is a governmental inducement, in effect, to turn precious metals markets into Ponzi plays during the periods where market prices are clearly detached from producer prices.

Wall Street Prices Speculative Potential, Not Fundamental Value

The stock market does not price real value but prices the nature and depth of expected speculation. Price discovery in the stock market exists only through the metric of price disequalibria. This perverse system of price discovery has evolved for the benefit of elites. While commodity prices have some tethering to reality, gold and silver have uncommon potential for pricing disequalibrias because hoarding is such a large part of current demand. While professional traders will place bets on the media driven retail perception that precious metals are counterpoised to dollar weakness, the elite bet is not on the dollar-to-gold relationship but the nature and viability of speculative perceptions.

Many gold bugs think the U.S. dollar is going to be destroyed by hyper-inflation. Some silver bugs believe their metal will soon be priced like “the gold of yore” ($300 an ounce). In this scenario, gold is slated to sell for 50 times more (about $15,000 an ounce). This psychology has created a complacency and has undermined diversification in many people’s portfolios. While asset concentration in precious metals worked great in 2010, past performance is no guarantee of future performance — and may offset it in amateur portfolios. Nevertheless, precious metals prices may continue to climb. Indeed, even though China is now mining more gold than South Africa, its growing middle class is so fearful of inflation that gold imports have soared over five-fold in 2010 (Mineweb, Dec. 30, 2010).

On July 27, 2010, gold broke through support around $1,150 an ounce and looked ready to test its February low around $1,000 an ounce (a situation I noted). However, by early October volume data in the SPDR gold ETF (and other anecdotal clues) suggested that big gold miners like Barrick Gold and Anglo Gold Ashanti had used the technical breakdown to reduce their hedge books. As a consequence it became apparent that speculative fever in gold was about to be renewed. The dip was just a head fake.

Rationally, the price of gold and silver should be connected to mining costs. However, since mine output cannot be ramped up easily, a disconnect can continue for some time. How long the disconnect continues depends upon various factors. Will the Chinese get inflation under control, thus discouraging the Chinese middle class from buying gold as an inflation hedge? Will the prospect of a silver price pullback — 30% is possible — cause the perception of silver as “protection” to change to a fear that additional silver purchases are the acquisition of risk?

Clearly, gold and silver have decoupled from a close inverse relationship with dollar strength. Since the credibility of the U.S. Treasury is being destroyed and not the value of the dollar, we could see the end of dollar prestige and reserve currency status while the dollar holds its own against money supply growth in foreign fiat currencies.

Precious Metals Pricing and the Soros Reflexivity Theory

While precious metals prices may continue their rise, it will eventually become apparent that some part of the pricing is “delusional” — a term billionaire speculator George Soros uses in his theory of reflexivity to denote the driving psychological force behind asset price disequilibrias. (Reflexivity means the price moves beyond what is warranted, then is jerked back to a polar distortion as it rebounds from the previous distortion. Wall Street’s financial architecture is designed to capitalize upon this phenomenon and use it to extract wealth from the general public and concentrate the winnings in its own ranks.) While delusions can serve as an extended foundation for asset valuations they can also become ephemeral — like 2006 housing prices. (Still, housing prices in the top 25 metro areas remain up 59% above year 2000 prices on a square foot basis.)

While gold and silver are positioned to remain viable stores of wealth in this era, the portion of their value that represents a misapprehension of how speculation will soon be priced is subject to retraction. (Explanation: By pricing the nature and depth of pending speculation instead of pricing the inherent value of the assets, the amplitude of price swings can be made more pronounced. This “pricing leverage” allows Wall Street to magnify its gains and build a wealth differential by which plutocratic ends can be secured.) Generally, Wall Street knows better than the general public how speculation is slated to be priced. Furthermore, pricing trends almost always incorporate unwarranted exaggerations or discounts to underlying value because of the reflexive nature of delusions.

Reflections on Stock Price Moves in 2010

Year end reflections must move beyond commodities and consider what has happened to stock prices. The Dow, S&P500 and NYSE indices are, on average, only 20% from their all-time highs — highs created when unemployment was low, credit was widely available, and the nation’s structural deficit was half of what it is now. (Obviously, there must be some perceptual discrepancies.) Meanwhile, the NASDAQ composite is only 6% off a 9 year high. And the really big index of small stocks — the Russell 2000 — is only 7% off its all-time high. These are stunning stock price movements less than 2 years after the Great Recession’s market lows — a reflection of the Fed’s relentless service to Wall Street. But are these prices sustainable? These stock valuations will undoubtedly decline as our own sovereign debt crisis nears, only to pop up again (briefly) once the crisis passes. (The resolution of America’s coming sovereign debt crisis will be short-lived: Expect global war and related catastrophes within a few years thereafter as international financial solutions come unraveled.)

There is incredible greed at play — greed that could drive asset prices higher. The U.S. Congress created a catalyst for the new wave of greed by loaning Wall Street elites free money during the crisis — ‘counterfeit money’ to buy up financial assets on the cheap (see “It Takes a Pillage,” Nomi Prins, 2009). These loathsome Wall Street elites want to pump up paper assets as far as market psychology will bear, then take massive profits by off-loading shares into the general public’s retirement accounts. Market clues plainly suggests the plan is to induce the investing public to rotate from weakening bonds (where they parked themselves in their recent fear) into over-priced stocks. Working people are being set up to jump from the frying pan into the fire just before the sovereign debt crisis hits — a prospect that Wall Street no doubt finds quite soothing as ‘they do God’s work’ (i.e., calling to mind the remarks of one Wall Street CEO).

Justice and legitimacy in America are dying because Wall Street runs a giant counterfeiting machine where illusions are traded for the public’s hard earned money. America is no longer the country that our brave soldiers died for. Aliens from a financially immoral dimension have taken a Manhattan Island beachhead and built a financial fortress from which they attack the nation with the goal of pushing people into a plutocracy. Unless America finds the strength to resist, this country will not remain the land of the free.