Making Sense of Gold’s Drop

Addison Wiggin – September 26, 2011

  • Margin hikes whack $150 off the gold price: A chart that shows why $1,600 gold is to be expected… and an outlook from Marc Faber that points lower still
  • Silver breaks below $30, while buyers swoop in and clean out a major dealer
  • Stocks rally on… [spinning the wheel]… talk of a revamped European rescue plan!
  • #OCCUPYWALLSTREET protests persist, take an ugly turn… A new commodity theft craze… Readers pick bones with Chris Mayer and Patrick Cox… and more!

   $1,800… $1,700… $1,600…

We don’t mean to frighten you today, dear reader, but an influential gentleman whose opinion we respect thinks it might end up going much lower.

Heh, not that he’s selling.

   Gold traded as low as $1,532 overnight before recovering to $1,603 as of this writing.

That’s a $50 loss tacked onto Friday’s $100 loss. Even examining the action in the context of a one-year chart, it looks dramatic…

   As of today, people who want to trade gold on the Comex once again have to post additional margin to their accounts.

Fueling the drop on Friday was an announcement by Comex parent CME Group: Gold margins were rising 21%. In addition, silver margins were raised 18% and copper, 16%.

An initial position on a 100-ounce gold contract will cost $11,475 up front.

This is the third margin increase for gold since August. Put together, the increases have totaled 55%.

   And today? The Shanghai Gold Exchange is following the Comex’s lead and raising margin requirements on precious metals.

   “Even with the recent correction,” comments Byron King, “gold is still priced within its long-term trading range” — as evidenced by this chart:

At $1,500, gold would remain within the “channel” that’s been in place for nearly three years.

   “We overshot on the upside when we went over $1,900,” Vancouver veteran Marc Faber told CNBC today. “We’re now close to bottoming at $1,500” — the bottom of the aforementioned channel, as it turns out.

But… “If that doesn’t hold, it could bottom to between $1,100-1,200.”

Not that Faber is worried. He’s been buying in since — well, probably around the same time we recommended our Trade of the Decade at the start of 2000, when gold was near $300.

   So here’s a little historical perspective: Gold first broke through $1,000 in March 2008, touching $1,010 briefly. That turned out to be a high point that wouldn’t be exceeded for 18 months.

By November, the Panic of 2008 was in full swing, and gold was at $715. That’s a 29% drop.

By September 2009, gold had reclaimed $1,000… and didn’t look back.

“With history as our guide,” says Matt Insley at Daily Resource Hunter, “it’s clear that gold’s been doing this sort of thing all along its massive run-up — since 2005 it’s seen five similar corrections.”

   So what now? Are we in line for another $29% drop… which would take us to $1,350? Or something steeper, as Marc Faber warns about? Will it take another 18 months for gold to reclaim the old highs and break through $1,900?

The good news is that you don’t have to know the answers to these questions to continue feeling confident about holding gold. “Nothing has changed since last week in the physical gold market,” Mr. Insley continues. “There wasn’t a mother lode discovery, and there’s clearly no substitute. So other than a market correction, gold is still high on our list of investable resources.”

“I’d buy every month a little bit of gold,” Faber advised back on Sept. 6, when gold was at its (for now) all-time high of $1,921. “When you buy gold, it’s an insurance against systematic failure and problems in the financial markets.”

Of which we still have plenty.

   Silver has broken below the level at which it began 2011. After trading as low as $26 an ounce overnight, the white metal has recovered to $29.95.

   Yet demand for silver is off the charts. Sprott Money, one of the arms of Eric Sprott’s Canadian fund empire, ran out of physical silver last week.

“We are temporarily out of stock,” Sprott Money president Larisa Sprott told King World News on Friday, although she was expecting a new shipment later in the day. “It’s been pretty wild, especially the last three or four days, because of the price drop.”

“People are trading in their paper money for gold and silver, but we are seeing more purchases of silver net. In fact, the buying has been really skewed in favor of silver, there is tremendous demand.”

“Our clients are very savvy, sophisticated and when a price drop of this magnitude occurs, they step in and buy very aggressively.”

   U.S. stocks are starting the new week in rally mode. The Dow and the S&P are up more than 1% each. The Nasdaq and the Russell 2000 are also up, but can’t muster the same strength.

After spinning the wheel in search of an explanation, the financial media have settled on relief that Europe will soon be fixed. Again.

   Never mind that no plan is in place. Right now, the plan amounts to this: G-20 leaders will spend the next six weeks drawing up a plan, and then take the wraps off it at their next meeting on Nov. 4 in Cannes, France.

Sort of brings new meaning to the expression “kicking the Cannes.” We’ll spare you the eye-gouging experience of spelling out the details that have been leaked… for they’re sure to change between now and then, anyway.

   One reason we’re pretty sure the plans will change: The International Monetary Fund says its $384 billion “emergency” bailout fund is too low.

“Our lending capacity… looks comfortable today,” says IMF chief Christine Lagarde, “but pales in comparison with the potential financing needs of vulnerable countries and crisis bystanders.”

Translation: American and European taxpayers will have to be bled even more to rescue spendthrift European governments. And by extension, the European banks that were stupid enough to buy those governments’ bonds. And by further extension, the U.S. banks that were stupid enough to write credit default swaps for the European banks.

   The #OCCUPYWALLSTREET protests in New York might not have much in the way of turnout… or a coherent message… but they do appear to have some staying power.

Launched nine days ago, the protests were billed as America’s “Tahrir Square Moment,” after the protests in Egypt. But a hoped-for turnout of 20,000 people ended up at less than 1,000 the first day.

One Reuters account described outrage at “bank bailouts, the mortgage crisis and the U.S. state of Georgia’s execution of Troy Davis.”

In any event, Saturday brought out the sort of police response that’s become typical at much larger protests: corralling nonviolent demonstrators, and perhaps innocent bystanders, behind a barrier of some sort — in this case, orange netting — and arresting them en masse.

And attacking them with pepper spray… for good measure?

The NYPD’s chief spokesman says the officer used pepper spray “appropriately.” Hmmmn… Appropriately for what?

   The “double dip” hasn’t arrived yet, at least according to one of the Federal Reserve’s most reliable recession indicators.

The Chicago Fed National Activity Index clocked in this morning at -0.28 for the month of August. Readings at -0.70 or below have signaled every recession of the last 40 years.

By this measure, the U.S. economy is not in recession again — more like suspended animation:

More than half of the 85 indicators that make up the index fell from July to August.

   To our long list of commodities that are the target of thieves — copper, scrap metal, fryer grease — we add a new one: hay.

“Round bales that used to sell for $20 are now topping $175,” reports KTVT-TV in Dallas. That’s insult added to injury for farmers struggling with severe drought. Hay has become so valuable that “even the hay falling off the bales on the back of a truck is being picked up, put in bags and sold.”

“If you want to steal a bale of hay, we’re going to press charges on you,” says rancher James Lockridge, having lost 150 bales worth $26,000. “You get caught stealing hay, you’re going to jail. We’re just not even going to play around no more.”

Must be well organized… because you can’t pick this up with two hands…

The shortage is getting so bad, it’s opening up a new business opportunity: One feed company is paying a finder’s fee to people who can track down willing sellers.

   “Oh, really?” a reader says sarcastically of Chris Mayer’s remark on Friday that panic and fear are driving quality stocks lower, not necessarily any change in the fundamental value of the assets or businesses.

“And what were the ‘fundamentals’ that drove the value of the assets up the last two years? I guess I missed that QE1 and QE2 improved the fundamentals of the market. I guess I missed that the big PD prop desk buying of the Russell 2000 futures — overnight almost every night for two years — that ran the market up was a fundamental factor.”

“Sure, profitability has been decent for a year, as companies whacked costs to the bone and sold like crazy in their overseas markets — and built inventory. But have you seen the S&P 500 earnings estimates dropping inexorably month after month? Have you seen the continued ‘unexpected’ growth in unemployment? Have you seen the ISM hovering fractions above contraction? Have you seen the Philly Fed’s pessimistic outlook? Have you seen the consumer confidence plummeting? Have you seen bank insolvency loom again? Have you seen… well, you get the point.”

“Stock prices have been propped up at every key moment of peril in the past two years by massive background buying — mostly overnight, when the impact can be greater due to low volume. This market is seeking its real valuation level, not taking a dip…. but go ahead… BTFD if you really believe in it.

“There may be another Wile E. Coyote rally, but this time, when he realizes that he’s hanging over the abyss — that Europe is collapsing and that this time, Mr. Fed is not able to hand him a parachute — I wouldn’t want to be long. If Mr. Mayer really recommends ‘picking up some things,’ he should really tell people to wait until those things hit the ground and stop falling. I can tell him, from personal experience, that not many people are good knife catchers.”

The 5: “This reminds me,” says Chris Mayer, “of that bit from Will Rogers. ‘Buy stocks that go up, and if they don’t go up, don’t buy them.’”

“I don’t pretend that I can pick the bottom. Still, I’ll invest in something for $10 that I think is worth $20-25. So what if it goes to $5 in the short term because the market falls out of bed? I may buy more or just sit. I am an investor, and this is what investors do. If you are not an investor, then don’t do it.”

“And on all that bad news? I quote Jim Fullerton, former chairman of The Capital Group in 1974: ‘Some people say they want to wait for a clearer view of the future. But when the future is again clear, the present bargains will have vanished. In fact, does anyone think that today’s prices will prevail once full confidence has been restored?’ The answer was no in ’’74, and it is no in 2011. Markets have cycles and this too shall pass, as the wise men say.

“It’s hard to impress on people, but the fact is that the best time to buy is when things look bad. Most people can’t do it. I wish the reader well.”

   “I strongly disagree,” writes another reader with a bone to pick, “with Patrick Cox’s comments about lifestyle changes to improve health.”

“One of our biggest problems is the cost of health care. A large portion of that cost is due to people eating garbage, becoming overweight, and then contracting heart disease, diabetes, etc.”

“People like me who exercise a lot have to pay for the other lazy, indulgent people who don’t take care of themselves. I’m not referring to people with genetic illnesses, cancer, etc. I’m referring to people who get ill due to factors that they can control.”

“Science might be helpful, but common sense would be even better.”

The 5: “The human race,” says Patrick, “has never before faced the dual conditions of vastly extended life spans with improved availability of nutrition. Even a generation ago, the poor tended to be thin. Real poverty meant malnutrition. Today, obesity among the poor is worse than among wealthier people. Nothing in our ancestral past has prepared us for this bizarre new world of long, calorically enhanced lives.

“For most of our species’ history, hunger was the critical biological mechanism that compelled us into constant action. Most of us automatically ate as much as we could to store as much fat as possible for inevitable periods of scarcity.”

“Now, without scarcity, that hunger has turned from a survival mechanism into a source of disease. Nevertheless, the same instinctual drives are operating still. The chemical cravings generated by shrunken adipose cells are simply impossible for most of us to resist for long. Only the thin person believes that obesity is due to a simple lack of will. It’s far easier, in my opinion, to quit smoking than overeating.”

“Fortunately, there are solutions. They won’t come, however, from changing human nature. That’s a fool’s errand. In the 20th century, massive efforts were made by utopian ideologies based on the premise that a ‘new man’ could be created. It didn’t work out.”

   “Earlier this year,” writes a reader continuing our conversation on how the IRS makes life difficult for Americans overseas, “I had great prospects for a new job in Norway with a Norwegian company.”

“I progressed through to the final interview. I didn’t end up getting the job, ostensibly for reporting requirements and paperwork with the U.S. government. I’m a Canadian citizen with U.S. permanent residency.”

“I also found out that U.S. permanent residents have to pay U.S. income taxes when they move abroad.”

The 5: Indeed, you do. Heck, imagine learning you had U.S. citizenship without even realizing it, and the IRS decided to go after you for failure to file.

No joke. It happened to Julie Veilleux, whose story we captured in Whiskey & Gunpowder last week. If you’re so inclined you can read about her plight here.


Addison Wiggin
The 5 Min. Forecast

P.S. Boeing delivered the first production model of the 787 Dreamliner today. The Japanese carrier ANA picked it up during a ceremony near the Seattle-area factory where the jet was assembled.

“I’ve seen the Dreamliner up close,” says our Byron King. “It’s a fabulous airplane. It’s the pinnacle of modern high technology. The aerodynamics are beautiful. The materials and structures are groundbreaking. The new, energy-efficient engines are exactly what the world needs. The interior of the aircraft will revolutionize the comfort and high standards of long-haul travel.”

“I believe that one can learn a lot about where the world is going by watching Boeing,” adds Byron. It’s not one of his recommendations, but “I watch Boeing because it’s a barometer for what’s happening in the big world. Boeing embodies high-tech, complex design, global manufacturing and logistics, energy use and much more.”

A host of revolutionary materials went into the 787 with the aim of reducing the plane’s weight… and as a result, its fuel consumption. That includes beryllium, about which we wrote on Friday. It’s six times as strong as steel… yet incredibly lightweight.

So it works exceedingly well in airplane parts like landing gear. A beryllium-copper alloy is also far more durable than steel or aluminum.

“Beryllium is critical to high-tech, aerospace, the nuclear industry, medical imaging and numerous other advanced industries,” says Byron. “And demand for this critical metal is growing.”

Byron’s research has unearthed a Canadian-traded beryllium producer. It’s still available at a bargain-basement price… but probably not for long. He tells you all about it in his latest presentation — still available for your review through midnight this Friday night.


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