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Lately the metals have been rallying in gold and silver.
Both metals ended last week on a higher note, with gold closing well at $1322 on Tuesday, gaining close to $140 since the Dec 31st 1180 low. Silver followed suit, hovering around the $21.80 mark.
Is this bullish sentiment sustainable?
Let’s explore two factors today.
First is the resumption of inflationary expectations. Such expectations are nowhere to be found in the developed world, but the Emerging Markets certainly has issues since the January sell-off in currency and equity. Currency devaluations and sell offs in Turkey, Argentina, Venezuela, Ukraine and a host of others have certainly stoked the inflationary expectations there.
In spite of unprecedented accommodative monetary policy, inflation in US and Japan has remained tamed up until now. Europe is still a different story, teetering on the edge of deflation rather than inflation, but there too things could change quickly. Most notably, wage growth, which usually feeds inflationary expectations, remains tame. And capacity utilization, a factor that affects wage growth, remains sluggish-below 80 percent in the US.
Simply put, should gold bugs expect any help from inflationary expectations?
The Dow Jones UBS commodity index is giving the first hint that commodities are putting in a bottom. As you can see since this commodity index has not been able to go below the 120 level on four attempts since June of 2013. Finally here in the first few weeks of February, we are seeing a break above the 5 year downtrend line from 2009 and in addition price has moved above the moving averages on the medium term changing the trend from bearish to neutral. We have advocated for a while that gold would need help from this sector in order to sustain any rally attempts. At the moment we are seeing the first glimpse of commodity inflation. Perhaps this change over the past few weeks has helped add to the bullish factor that has powered gold and silver higher in the past two weeks. The other factor we should be on the watch for is the crushing drought that has encircled California.
 
California, the U.S. state that produces the most vegetables is going through the worst drought it has ever experienced and that the size of the total U.S. cattle herd is now the smallest that it has been since 1951? If the drought that has been devastating farmers and ranchers out west continues, we are going to see prices for meat, fruits and vegetables increase dramatically. Already, the federal government has declared portions of 11 states to be "disaster areas", and California farmers are going to leave half a million acres sitting idle this year because of the extremely dry conditions.
"It's really a crisis situation," exclaims one California city manager, "and it's going to get worse in time if this drought doesn't alleviate." For the state that produces one-third of the nation's fruits and vegetables, the driest spell in 500 years has prompted President Obama to make $100 million in livestock-disaster aid available within 60 days to help the state rebound from what he describes is "going to be a very challenging situation this year... and potentially some time to come." As NBC reports, Governor Jerry Brown believes the "unprecedented emergency" could cost $2.8 billion in job income and $11 billion in state revenues - and as one farmer noted "we can't recapture that."
The consumer price index is released on Thursday and we’ll have to see what it looks like and if prices are being affected yet.
Second is the revival of sovereign debt concerns. This time around, the epicenter of the next debt crisis may be in Asia rather than Europe. In an article published recently in Barron's, for instance, Carl B. Weinberg expects Japan to go over the cliff. "Elementary economics suggests that Japan's reflationary policy is about to fail. Abenomics is leading the country into recession, high debt, and a trade deficit."
Will that revive demand for the two precious metals or will it add to the deflationary pressures we have seen? Investors could rush out of Japanese treasuries, as was the case with European treasuries two years ago. Nonetheless, the size of such trade could be enormous, given the clout of the Japanese economy.
Last but not least is the growing the US-China conflict in the Asia-Pacific region.
In fact, China is another country with looming sovereign debt problems. Though the country continues to expand at healthy rates, momentum is ebbing -- as the Chinese government begins to crack down on the shadow banking system, which provided fuel after the 2008-9 global crisis.
"Shadow banking presents an especially difficult challenge," write Lingling Wei, Bob Davis and Shen Hong in a recent piece in The Wall Street Journal. "On one hand, Beijing wants to encourage the development of non-bank financial institutions, which often lend to smaller firms that are overlooked by China's biggest state-owned banks ... On the other hand, the rise of shadow banking has been a major reason that debt has increased at a pace similar to the US, Europe and Asian nations before they crashed."
How likely is each scenario?
It is hard to say. What we can say is that sovereign debt crises can be hidden much longer than we tend to assume, especially for large economies with their own currency. But they create havoc in global markets when they break out, fueling precious metals rallies, as investors flee ailing currencies.
Compounding the problem, the breaking of an overseas sovereign debt crisis could prompt the Fed to abort its on-going tapering program.
What does all this mean for investors?
Take a gradual approach. Accumulate precious metals rather than chase after them. And monitor closely the Japanese and the Chinese economies, watching for events that may cause a Greek style crisis and the Emerging Markets.
Finally, the FOMC minutes come out today at 2pm NY time and CPI inflation report on Thursday. Both can be moves for the metals.
Gold Chart
Gold has resistance at the mini blue line channels. A push above the next mini blue line would again open the upside towards 1335-1340. Odds at the moment favor that any correction from 1322-1332 area will be short lived and not very deep. Maximum I see is an orderly correction to the lower dotted trend line nea 1285 or 1290. But there is also support at 1297 an 1306-1310.
After such a correction or just a pullback the upside action favors a continuation and should break 1322-1332. Monday and yesterday´s close above 1322 was a hint that this move still wants to go higher. The problem was Monday was a holiday in USA, so do we count the close above 1322? And Tueday’s close on the COMEX was 1321.80 and GLOBEX 1322.20! Was that close enough?
I’m not sure how to play it exactly because the FOMC minutes are released this afternoon. Do we get a HFT (High Frequency Trade) spike down to clear the stops then move higher or do we just continue higher. Finally, if silver makes a new high to day on FIB day 34 at 22.20 resistance --- do the metals begin a pullback from there or just power higher? And if one is to go long here, what is the stop loss on initiates. If we get a pullback to the 1296-1308 area, to me it would be a place to speculate and get a trade long going with a stop at 1277 or 1280. The best would be to have it trade at the lower dotted line at 1284. But that may not be in the cards.
Silver Chart
Silver seems to be consolidating and looking to go higher. But the risk reward here doesn’t look good as silver could peak near 22.10-22.20 and pullback as its on its 34th day from the low. It can also just keep going and power to 23.10. We recommended in January for physical buyers to add to positions (as we did in gold), but the question of a trade here has a lousy risk/reward factor buying this high. Support is 21.30-21.50 and then 20.70-20.90. Buying a pullback or spike down to 20.75-20.85 would be worth a short with a stop at 20.20 but it doesn’t seem likely we get it unless The FOMC minutes are used to spike down silver and reverse it higher. Perhaps silver makes a high near the dotted trend line just above 22 and then begins a pullback from there? Either metal is hard to determine a good entry point. The bottom line at the moment seems that the pullbacks should end either today or tomorrow and begin another up move if short term cycle is up.
On the long term, the silver LOG scale chart shows we have supported at the channel line and the bull market is still in effect.
Gold Cycle
And that brings us to our final chart. The yellow and blue on the left is the July/Aug rally. We have favored a July/Aug rally since the end of Dec. The final phase would be for the blue cycle to not correct but instead push higher to the next red cycle. We are at resistance in gold at the dotted line. Do we consolidate for a few more days, then begin higher or do we push through right now? We don’t have a firm answer. A close above 1335 has to favor higher but watch silver at 22.10-22.30. There’s resistance there as well. If we don’t make a new gold high and silver hits 22.20 and begins to pullback, we’ll expect a pullback to ATTEMPT TO DEVELOP.
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