Why Did Gold and Silver Pullback?


By Eric McWhinnie

Aug 25 2011 10:34AM


It was an ugly day for precious metals (NYSE:DBP). On Tuesday, gold (NYSE:GLD) and silver (NYSE:SLV) both fell as the Dow (NYSE:DIA) gained the most points in two weeks. Gold dropped the most in a year after reaching a new nominal high of $1917.90 per ounce.  Silver also declined and reached a session low of $41.50 before rebounding back above $42. Since gold and silver often play off each other, let’s take a closer look at gold as it provides a clear reason for the pullback.

As silver bugs will recall, back in April and May, silver margins were hiked 5 times in less than two weeks. The margin hikes sent silver tumbling from $50 an ounce.  Since then, silver has struggled to sustain a move above $40. The strong precious metals rally last week powered silver to a new short-term high of $44.28 on August 22.  On the same day, gold reached a high of $1917.90. However, gold and silver both saw sharp selloffs yesterday. As the chart below shows, gold has seen this type of move before.

The prior sharp selloff was seen on August 11. This is significant because the CME increased gold margins by 22%, effective after the close of business on August 11. The same beat down method seen in silver months earlier, was seen in gold. However, gold recovered quite well until yesterday’s sharp selloff. So what caused this familiar selloff in gold and silver? Another margin hike!  Late Tuesday, it was announced that  The Shanghai Gold Exchange increased gold margins for forward contracts, the second time this month. Li Ning, an analyst at Shanghai CIFO Futures said, “Gold prices on the global market have been rallying strongly and at an increasingly faster pace. The margin hike is a pre-emptive move in case prices crashed and caused great volatility in the market. The Shanghai Futures Exchange could raise margins on its gold futures contract soon too.”

For our premium newsletter subscribers, I warned about this exact situation on Monday. I said, “Gold will meet resistance near $1900-$1950. As gold approaches the higher end of this range, be cautious of another margin hike in gold.”  Many investors may be wondering where gold goes from here? The prior CME margin hike sent gold down 5%. If you apply the same 5% pullback to the recent high of $1917 in gold, you get a gold price of about $1821. Yesterday, gold for December delivery reached a low of $1826. Yesterday’s low also coincides with our warning to premium newsletter subscribers. On Monday, I also said, “Margin hikes worked extremely well a few months ago to dampen silver bugs, but investors should see this as another buying opportunity. Gold will find short-term support at $1825, and even more support at $1800.”

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By Eric McWhinnie


Eric McWhinnie is the Chief Commodities Analyst at Wall St. Cheat Sheet. Visit the newsletter page for information on our premium service.