By Ben Kramer-Miller

The recent rise in gold and silver prices appears to have sufficiently convinced many that the bear market is over.  In past rallies in the beginning of 2014 and 2015 precious metals spiked near the beginning of the year before facing selling pressure driving them both to new lows.

However the 2016 rally has persisted, and it has recently been confirmed by silver’s outperformance (silver tends to outperform gold during precious metals bull markets).  Silver had actually lagged gold towards the beginning of the year although it has begun to break out, so that silver is up 24% vs. gold’s 18%.  Mining shares have also confirmed, with stocks of some companies–primary silver miners in particular–having already jumped several hundred percentage points off of their lows.

Many analysts–even long-term bulls–continue to doubt that gold and silver have bottomed, and while they may be right the odds are tilting against them being right.

We’ve noted in the past that there are signs that the gold market has been in a bottoming process for quite some time.  Two points in particular worth mentioning include:

  1. Gold has resumed its bull market in most foreign currencies, and depending on the currency this bull market is well over a year old.
  2. Many gold miners bottomed in 2013-2014 and are in sustained uptrends that indicate the resumption of a long-term bull market (e.g. Klondex Mines).

These are more indicative of a bottoming process than an actual nominal bottom, which is why both preceded gold’s nominal bottom.

During the past couple of years–and this is ongoing–there a have been various forces working against the gold market such as the bull market in “low risk” bonds strength in the Dollar Index, and a stock market that looks cheap on a cash-flow yield basis when compared with the risk-free interest rate and “low-risk” bonds (e.g. investment-grade corporates, some municipals and sovereigns).  This has been accompanied by strong demand for cash (i.e. a low and declining velocity of money) and negative price action caused by speculative short-selling fueled by manipulative short-selling (which is now publicly admitted, but which had been kept secret (or as secret as possible) for more than twenty years).

These bearish factors for the precious metals markets have been reversing themselves over the past few months, starting with the Fed’s rate hike in December.  This preceded the bottom in the gold market by a day after analysts almost unanimously predicted that this would lead to further downside.  Subsequent to this we’ve seen:

  • Stocks appear to be testing a long-term top.
  • Short-term rates appear to have bottomed.

These reversals are not immediate and are taking time to manifest.  After all the Fed isn’t rushing to raise rates further and we’ve seen speculation that they may reduce rates, resume quantitative easing, or implement negative interest rates.  However the Fed cannot stop these trends unless it prints money to buy stocks and bonds.  Even so, the increase in the money supply would potentially spill over into other asset classes, which we didn’t see during the last QE given the aforementioned bearish factors.

Some Recent Market Developments

The Commitment of Traders Report shows a sharp rise in the number of commercial short positions throughout the 2016 rally, and this generally precedes a market decline.

The “imminent gold breakdown” prediction makes no sense: if it were true one could have made that call when the commercial shorts reached the level they did last October (and Clive did).  Commercial traders usually get the market direction right, although we can see that the timing is less predictable.  It is worth pointing out the extent to which this commercial short position increase is anomalous: something is different this time around,.  We don’t know what it is, so without an explanation or a correction of the anomaly (i.e. a sharp decline in the gold price over the next few days) the indicator is not useful.

Deutsche Bank Settles In The Face Of A Market Suppression AccusationA week ago Bloomberg reported that Deutsche Bank has settled with plaintiffs in a class action lawsuit who are claiming losses as a result of the bank’s market manipulation efforts in precious metals futures.

We note that Zero Hedge published an article suggesting that this admission doesn’t reveal the big picture.  As those familiar with the suppression conspiracy theory are aware central bankers have been leasing out gold in order to increase the supply and suppress prices.  They cover this up by not differentiating between “gold reserves” and “gold receivables” on their balance sheets, and in this way they have succeeded in increasing the perceived global gold supply.  This theory–described in detail here–goes back to observations made by Frank Veneroso, who around the turn of the century observed that demand on paper exceeded supply by a significant amount, and he concluded that central banks and the World Gold Council grossly understated the amount of gold the former had leased.  Around the same time the IMF announced that central banks would stop making the aforementioned differentiation between “gold reserves” and “gold receivables.”  So while just a theory Veneroso’s explanation of disparities in the data offer the simplest explanation as to where all of that extra gold came from.

The Deutsche Bank scandal is different, and probably not as important.  Commercial banks rig the gold market over the very short-term–over a period of a few hours, or even a few minutes, but with regularity so that it is extremely easy to verify.  Dmitri Speck’s book The Gold Cartel (our review is linked above) demonstrates that the price action before the London AM and PM Fixes (especially the PM fix) is extremely volatile and consistently negative, leading to what precious metals traders refer to as a “smash” or a “take-down.”  It doesn’t happen all the time, but it does happen with sufficient regularity so as to be statistically significant to an incredibly high degree of certainty.

So Can Gold Go Lower On Paper Selling?

The potential for paper selling has  been a potential bearish factor in the gold market for years, and it wouldn’t surprise us to see additional selling that drives the price lower.  In fact this is supposedly what the commitment of traders data is suggesting.

This possibility and the general impact of futures selling on the COMEX have been gradually declining as the COMEX has lost its role as the primary exchange for precious metals.  In fact almost no gold or silver actually change hands as a result of COMEX trading since it consists mostly of paper bets–both long and short.  Many believe that the Shanghai Gold Exchange–now the world’s largest physical gold exchange–will mitigate the influence of the paper selling that has upset the plaintiffs against Deutsche Bank.  After all, it is this paper selling and the layout of the paper market on the COMEX more generally that has CoT watchers bearish.

As always, the best we can conclude is that paper selling can have a strong impact on the market in the very short-term.

Can Gold Move Lower For Other (i.e. Fundamental) Reasons?

There are still plenty of analysts out there making fundamental cases that the gold price will fall.

The most popular in the mainstream financial media is that the Fed will raise rates and that this is bearish for gold.  Historically this is simply not the case, and we have illustrated this numerous times.

We came across another bearish article suggesting that gold has outpaced the CPI.

Another still points to the potential for Dollar Index strength and continued commodity weakness.

We view such arguments as unfounded: measures such as the CPI and the Dollar Index are highly specific and potentially skewed measures that have little to do with the purchasing power of the Dollar.  We note that the CPI corrects a lot of the input data as described here, and that the Dollar Index is an arbitrary measure of the Dollar’s value, and is more a measure of the Dollar’s value vs. the Euro than anything else.

Thus while a lower-than-expected CPI or a sharp spike in the Dollar Index could pressure gold near-term, there’s no direct fundamental reason for the correlation, leading us to the conclusion that so long as gold remains undervalued that these indicators are at best temporary predictors and at worst misleading.