Gold and silver prices crashed through key support levels last week and could be on their way down to their respective major support levels $1,525 (£1,000) an ounce and $27 an ounce. Should prices plunge further than that, all bets are off. Indeed, if the last bear market for precious metals is anything to go by, prices could go into hibernation for as long as 20 years.
Even habitually bullish commentators on gold are starting to openly ask whether precious metals prices actually reached their zenith back in 2011 and are now in long-term decline. Most actually don’t think so. Technical analysis suggests this is merely a short downturn within an ongoing bull market for precious metals that has been running strong for 12 years.
Time to retreat
We’re not convinced of either case just yet, but for now the risks seem skewed to the downside. As a result we’re downgrading several of our recommendations on precious metals miners and advising investors to reduce their exposure to gold and silver-related equities. Below, we set out new recommendations on over a dozen precious metals equities, separated into ‘sell’, ‘hold’, and ‘buy’ sections.
So why have prices suddenly dropped? As we explained last week, there are two main reasons for the abrupt sell-off. The first is entirely technical. Gold has been trading within a range of $1,800 to $1,525 an ounce for the past year and half. Twice gold has failed to break through $1,800 and subsequently drifted back to $1,650 and then $1,525. When gold rose for a third time in October following a third round of quantitative easing by central banks, but then failed to break through $1,800, it created what technical analysts call a ‘triple-top’ formation. Prices once again fell back to support levels – first $1,650, and likely $1,525 shortly.
The second reason is that the ‘fear trade’ is temporarily off. The key drivers of gold these past few years have been fears of inflation, a eurozone breaking up, a US dollar collapsing and the ‘fiscal cliff’. These fears have waned over the past few months. Gold bears from Citigroup now argue “the world has passed its worst point of systemic risk to the global financial system and that the ‘insurance metals’ (gold and silver) have had their day in the sun”. That's because the global economy is seeing early signs of a return to growth - albeit very minor growth at this stage, admits Citigroup - while bond purchases by the European Central Bank have curtailed the worst of the eurozone debt contagion. Likewise, the US dollar is being underpinned by cheap energy supplies from fracking for shale oil and gas, so the long-term bearish argument on the dollar has reversed.
But have the structural problems within the US and the eurozone disapeared. The issues of excessive government debt as well as the proliferation of paper money, have not remotely gone away. In fact, there is talk of yet more quantitative easing needed in the UK and elsewhere, while the deadline for the next US debt ceiling negotiation is fast approaching. What's more, mixed election results in Italy have just brought the economies of the eurozone periphery back into focus.
We don’t believe the world has seen the full extent of the fallout from the 2008 financial crisis yet, but the problems have been successfully papered over by governments and central banks so as to keep equity markets rising. How long they can artificially keep their economies pumping is anyone’s guess, but it could foreseeably last a while, potentially even several more years (remember, it has been five years already!).
All of which leaves us with a dilemma. By selling out now, would we simply be following the herd and miss the bull market when it resumes its upward trend? Or would we be avoiding further carnage in precious metals equities as gold drops to new, unforeseen depths? Investors must make up their own minds here, but we’ve decided to err on the side of caution for now with our our changes in the share recommendations below.
With one eye fixed on locking in whatever gains are left from gold’s resurgence last autumn, we are closing out several of our gold-related buy tips, including
Nevertheless, we feel obligated to close out our heavily-underwater buy tips,
Aureus Mining listed when the gold price peaked in 2011 and has had a difficult time gaining traction ever since, even though it has advanced its flagship project in Liberia to a construction-ready state. We still like its future prospects, but it’s tough to see the near-term catalysts that will drive the shares back up to where we first recommended them before production starts.
In a similar vein, we downgrade ancient buy tip
As for the more trouble-prone gold miners –
London’s top gold miner,
We keep recent buy tips
by Angelos Damaskos, chief executive of Sector Investment Managers and fund adviser of the Junior Gold fund
In the last two years, gold mining equities have been sold-off disproportionately to the price of gold. Investors seem to believe that the gold price peaked in August 2011 at $1,927/oz and is now in a downtrend as global economic prospects improve, and there is an apparent stability in the Eurozone. The current sentiment suggests that, if gold continues to drop, miners’ profitability will be squeezed, especially as cost inflation has eroded margins in recent years. People believe there is little point holding gold-mining shares in such a scenario.
This thinking does not however allow much margin for likely disappointments in macro-economic factors. The Eurozone remains unstable and in economic recession, with popular unrest, high unemployment and continued austerity measures. There is still a significant probability of a banking crisis even if we assume that any sovereign debt issues can be addressed by the ECB. On the other side of the Atlantic, the “fiscal cliff” and “sequestration” are currently being debated by the US Congress and, despite a general willingness to find a solution, the result is likely to be a compromise, involving budget cuts and tax rises. These could easily throw the US economy back into recession, as the GDP reading in the last quarter of 2012 indicated. Any of these events is likely to force central banks to act in new and radical ways, prompting a flight to safety, in particular gold.
In the current circumstances, mining management teams have put cost control at the top of their agendas. An obvious and immediate way to improve profitability is the focus on higher-grade deposits, at the expense of production volumes. As marginal deposits are scrapped from business plans and unprofitable operations are shut-down, global production is almost certainly going to decline. A new surge in demand might come at a time when supply is tight, causing a crunch that could push the price of gold to presently unimaginable levels.