Is There A Bright Side To The Week’s Gold Plunge?

February 6, 2010 | By | Reply More

Gold IngotDespite the slaughter on Wall Street this week as reality took center stage, spot gold ended up only $20 down during this period. Over the previous month, however, things have looked far from encouraging on the surface for gold bulls. Spot Gold has tumbled from over $1160 at its peak to Friday’s after hours close at $1066. “ Courage mes enfants” as Napoleon is supposed to have exhorted his elite guard at Waterloo, for we forecast a bright side to this months gold plunge.

We believe that this week has shown that it is mainly the short-term speculative money that has taken fright or sold short on the correct premise that precious metal prices will follow the rest of the stock market down. OK, so the dollar has strengthened considerably against the increasingly fragile looking Euro and Pound.

Deflation is increasing in Japan whose twenty year policy of quantative easing, i.e. throwing newly printed paper disguised as money at non productive schemes, is now being slavishly followed by the US and Europe. Doubt has been cast on China’s continuing ability to grow at 8-10% p.a. without bursting a bubble when they have now taken over from India as the major world buyer of physical gold.

In the meantime oil has sustained only a minimal price drop and we remember that not so long ago gold investors were led to believe that the gold and oil price were inexorably linked. We never went along with that point of view but if that were so, then gold will inevitably bounce back, most probably in the very near future.

As for the longer term, the last month price action has only served to strengthen our resolve to stick by the yellow metal. It seems to us that there is still considerable underlying strength and that the metal is greatly oversold.

Deflationary prospects are a factor to consider but in the face of the amount of fiat money continuing to pour into the vulnerable western economies conflicting with the growing positive economic activity and fiscal reserves of the BRIC nations and energy producing countries, who can be bold enough to predict that the Dollar, Pound or Euro will buy the same amount of globally essential goods in 12 months time as today – not a chance!!

Silver is another matter and we have to confess to doubts creeping into our previous very bullish stance. We have put our money where our mouths are by buying SLV July call options at strike rates of $18, $19, and $20 respectively and are still tempted to top up at yesterdays even lower prices. Thank goodness that we bought options and not stock in SLV, at least we know to the penny how much money we are at risk of losing.

The problem with silver is that it is a much smaller market than gold, meaning that it is much more reactive to it’s financial flows than gold. This volatility makes it easier to affect, some with justification may say manipulate, the market. As the prices of silver and gold have historically moved up or down in tandem there is a knock on affect on gold.

This may seem at odds with our views on gold in both the short and longer term but we note, with optimism, that the gold/silver ratio is now very close to 70, when approaching 60 has been the recent and healthier norm and historically below 30. This taken together with the fact that physical silver, unlike gold, is not a constituent or on the buy/sell list of the reserves of countries and national banks.

A round about way of saying that this may be a last chance of buying physical silver or producers at these low prices if you have strong nerves and a calculated gambling instinct. If silver does move it will fly compared to gold.
Or you may prefer to sit on the fence, like us, and wait and see which way the silver wind blows.
GLD call options for the second half of 2010 or later seem to be a safer and better bet.

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