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Gold and Silver Shine During the Race to Debase

Commentaries & Views

European Central Bank (ECB) President Mario Draghi's neutral tone yesterday influenced some normal profit taking from the shorter-term futures traders in overbought August Gold. In a precursor to a rate cut, the ECB said it saw rates at present or lower levels through mid-2020, a subtle change to its previous pledge to keep rates unchanged through next June. After the bank kept rates unchanged, Draghi said it was devising a stimulus package, possibly for September.

The ECB remains trapped and once Draghi told the markets to be prepared for more easing measures into 2020, the euro briefly fell to a two-year low against the dollar. More than ten years of quantitative easing has utterly failed, so now Draghi is unable to return rates to normal levels without bankrupting the ECB and cause all 28 member states of the EU to pay more in interest.

With the ECB currently owning about 40% of the debt of member states, they have to keep rolling it or the free market will extract its pound of flesh with higher rates. I imagine Draghi is counting the days until he leaves office on October 31st, only to be replaced by Christine Lagarde who is predominantly a lawyer and may lack the proper experience in how markets function.

Meanwhile, August Gold continues to consolidate its recent gains within a bullish pennant formation above $1400. One month ago, gold made a dramatic move above a six-year consolidation base with a quarterly close above $1400, confirming for technical analysts that a bull market in gold is now taking place. Pennants are continuation patterns, wherein a period of consolidation is usually followed by a breakout movement in the same direction as the initial large movement.

If the consolidation does indeed break out to the upside, the technical target is $1550. This was also the critical level broken in early 2013, which ushered in a nearly 50% correction from its peak above $1900 to the low made in December 2015 below $1050.

Next Wednesday the Federal Reserve is expected to deliver its first interest rate cut since 2008. According to the CME’s FedWatch tool, there is a 100% probability that there will be a rate cut announced at the FOMC meeting on July 31st. The tool indicates there is a 76.5% probability that the rate cut will be 25-basis points (1/2%), and a 23.5% probability that the rate cut announced will be 50-basis points (1/4%).

With global growth slowing, central bankers around the world have taken a more dovish turn toward monetary stimulus which has been weakening their local currencies. The Fed is the most recent central bank (and the biggest) to telegraph lower interest rates and a weaker dollar. This is one of the main reasons that global traders have turned to gold as a new store of value during this “race to debase”.

While gold is experiencing a healthy consolidation period, we need to remain focused on the big picture as the market is beginning to figure out that the Fed is in a box, along with the ECB. The central bank of the world’s largest economy cannot tolerate higher interest rates or lower stock prices and the math suggests they are going to have to print enormous sums of money to support low interest rates and high stock prices. This money printing will be wildly inflationary, keeping both gold and silver well bid while global central banks are forced to maintain loose monetary policies.

The most important recent development in the precious metals complex is that gold is now trading as more than just a commodity. When global traders lose confidence in their currency, they often turn to gold as an alternative store of value. The main message is that gold has now become the world's strongest currency, as well as one of its strongest commodities.

The recent breakout in gold is a sign that global traders are losing confidence in their central bankers and their currencies, which is probably the reason why the metal has been shrugging off the more recent strength in the U.S. dollar. The true hallmark of a bull market in gold, however, is its ability to rise relative to other major currencies. 

The price of gold quoted in Aussie Dollars continues to make all-time highs and has been joined there recently by three other major currencies. Gold priced in the Japanese Yen, Canadian Dollar, and the British Pound are all trading at their respective all-time highs. The euro has been this year's weakest currency thus far, so the price of gold quoted in euros is doing even better, as the chart of gold always looks stronger when quoted in a weaker currency.

This is the price global central bankers are paying as they race to see who can lower rates the most, or go the deepest into negative territory. Since gold is quoted in U.S. dollars, it rises in value when the dollar weakens and is one way for investors to preserve their wealth when the Fed starts to lower interest rates and weaken its currency.

Gold rose to a six-year high last week on falling U.S. interest rates which weakened the dollar, aided by a more dovish Fed. So, gold in U.S. dollar terms is beginning to catch up to gold priced in all other major currencies.

After leading gold higher since early May, the extreme overbought GDX has been consolidating its gains as well, however, many of the higher risk juniors began leading the miners this week. Historically, during major gold up-legs, the big-cap miners and royalty firms move first, then silver and the juniors begin to catch up quickly.

For the first six weeks of this gold move, silver and many of the juniors have lagged gold and its miners considerably. Then last week, silver began running higher, significantly outperforming gold. But some of the junior development and earlier stage exploration stocks were still stuck in the mud until this week. 

With the market pricing in a $1400 gold floor, silver is beginning to catch up. Many of the higher risk juniors, which have yet to move up much, are beginning to receive more attention. Both silver and the micro-cap juniors are higher risk, so when silver begins to move, the juniors usually follow suit.

Moreover, momentum players late to the gold party are searching for value down the miner food chain. Why chase miners that have already made huge moves to the upside, when you can get into best in breed juniors that are trading at lower risk entry points and presenting excellent value?

When the highly leveraged small and micro-cap junior precious metal companies start their runs, they can double or more within weeks, like we just saw last week out of the blue in a few select silver juniors. I have been painstakingly researching and accumulating the best in breed developer/explorers and early stage micro-cap juniors for the past three years, in anticipation of the recent breakout in the gold complex. If you would like to receive my research, newsletter, portfolio, and trade alerts, please click here for instant access

Disclaimer: The views expressed in this article are those of the author and may not reflect those of Kitco Metals Inc. The author has made every effort to ensure accuracy of information provided; however, neither Kitco Metals Inc. nor the author can guarantee such accuracy. This article is strictly for informational purposes only. It is not a solicitation to make any exchange in commodities, securities or other financial instruments. Kitco Metals Inc. and the author of this article do not accept culpability for losses and/ or damages arising from the use of this publication.