Got Gold Special: Are we there yet?

Random thoughts starting with the monthly charts of gold and silver...

EVERY ONCE in a while we share some of the charts we find interesting with our Got Gold readers in a bit of a less structured format, writes Gene Arensberg from Houston, Texas for the Gold Newsletter.

Looking now at the long-term monthly chart for Gold Prices, it "says" we're close but not quite yet "there" for this surge cycle. Of course that assumes this surge will dance more or less to the same music, the same set of rules, as the previous six surges of the last nine years.

That's an arrogant assumption because it proscribes both lesser and greater events. If history has taught us anything it has taught us that both lesser and greater results are certainly possible – perhaps even to be expected.

In the weekly gold chart below, the "goal line stands" taken by the large commercial hedgers and short sellers in Comex Gold futures in 2005 and 2007 show up in the first two orange circles. Their net short positioning was overrun then.

The green circles show where the bull surges finally peaked between 60% and 70% above them.

Depending upon exactly where one draws the starting line, gold has advanced some 30% or so since it broke out of its wide consolidation. It has advanced as much as 21% since net short positioning taken by the Comex commercials (bearish bets minus bullish nets) reached a record high on September 22.

Like gold, meantime, silver is also working its way back into a more popular status, gradually, but surely. As time passes we look for silver to outperform gold strongly if the world more or less holds things together.

When the Gold/Silver Ratio (GSR) is falling, silver is outperforming gold. If a surge in silver demand similar to the late 1970s occurs, look for this ratio to collapse to something well under the lowest readings shown in this 20-year print, perhaps even into the low 30s or upper 20s.

If the gold/silver ratio were at 30:1 with $1150 gold, that relates to $38 silver. At 20:1 it would be $57.50 the ounce.

Moving back to gold, however, this graph measures the purchasing power of gold relative to the US Dollar. When rising Gold Prices mean it's gaining in purchasing power, the Dollar is losing purchasing power.

The graph is also a measure of the confidence in the greenback inversely. As confidence in the buck falls this ratio rises and vice versa. But the Dollar is not unique in its loss of purchasing power. Look at gold's purchasing power compared to the Pound Sterling, or against the Euro. People all over the world are fleeing under-backed, fiat paper currencies and it's clear they seek to protect their purchasing power with gold and to a lesser extent (so far) silver.

Despite the remarkable rise in value of gold, and its obvious increase in purchasing power, it has not been a picnic for the smaller, less well capitalized, more speculative miners and explorers such as those residing on the Canadian exchanges.

Relative to their larger cousins, the big, well-capitalized companies which make up the AMEX Gold Bugs Index or HUI, smaller, and more speculative companies such as those that populate the Canadian S&P TSX Venture index continue to see less than enthusiastic support.

Part of the reason for that is likely because all of them took suck a bludgeoning in 2008, with many of the formerly high-flying speculative companies losing more than 70% of their price value from the end of 2007 to the end of 2008.

The chart above looks at the CDNX "priced" in gold. Although some smaller companies have seen tremendous popular support and some have even gone on to dazzling new heights, as a group relative to gold they lag. This is either an opportunity or a warning. It cannot be both.

As 2009 comes to a close we are cautiously optimistic that so long as the world continues to believe that the global financial system will not face a full-blown systemic threat again; so long as the world avoids a collapse in confidence in the institutions, the machinery of commerce; so long as we avoid the prospect of another panic implosion, the smaller, more speculative junior miners and explorers offer considerable opportunity going into 2010.

One measure of confidence in the global banking system is the TED spread. It more or less measures the spread between LIBOR and Treasuries. So long as this ratio remains "sane" we can conclude that bank-to-bank confidence is not showing undue stress. As of early December, the TED spread is "sane."

We are amused that some otherwise very smart people in the financial press are now saying that gold is currently in a bubble. They may or may not be right very short term, but we continue to believe that no "bubble" in gold can exist until the general public becomes fully involved in it.

The public in the US was involved in the housing bubble just before it failed in 2007. The public was involved in the dot-com bubble just before it crashed and burned in 2000. So long as our monetary policy is controlled by central bankers that are swayed by political and market expedience; so long as the Fed and Treasury can "create" more currency than they can back by something tangible, there will always be market bubbles. However, just because something has risen in price; just because capital and liquidity flows into one thing or another, even a lot, it doesn't necessarily follow that particular something is in a bubble.

Presently we can conclude that the general public is not involved to any large extent in the gold trade by looking closely at its sister metal, silver. When the public becomes strongly involved in precious metals silver excels for a whole host of reasons, including its tiny market size relative to Gold Bullion, ETFs and futures, the general public's belief that silver is "the poor man's gold" and an amazingly small global inventory of silver metal available for investment.

As anyone can see, as gold has moved on to new and exciting nominal highs, silver has lagged and lagged badly. We take that as silver plated proof that "Joe Average" (as well as "Hu Average" and "Juan Average") are currently not yet involved in the precious metals bull market. Not even close.

We might be wrong, of course, but we do not believe it is possible for gold to be in a bona fide "bubble" without full participation by the general populace – and more critically, full participation in silver, too.

Silver is, therefore, our canary-in-coal-mine barometer for gold "bubbledom". Because in today's global world of massive money creation and interconnected markets...with competitive fiat currency devaluation and extremely low interest rates force-feeding oceans of capital into all commodities...when the world's primary reserve "currency" is declining in both prestige and confidence...and with the rise of so many more people of affluence and means in China, Brazil, Russia and India...the "general populace" includes a great many more individuals.

Individuals who will be using vastly more fiat paper and electronic Dollars, Pounds Sterling, Yen, Euros, Yuan etc...several orders of magnitude more fiat currency...to chase a little more gold and most likely less than half as much real physical silver metal than in the last liquidity-driven bull rush for metals.

When the general public becomes fully involved in gold, silver shines brightly for a time. At least it did so in the last public rush into gold which peaked about 30 years ago.

Therefore, the current surge event for gold is likely what GoldMoney founder and deep thinker James Turk calls "the beginning of stage two" of the gold bull market. The stage of the precious metals bull cycle where the general public is still in disbelief, but where institutional money and smart wealth is in fact flowing into them.

Some analysts attribute the underperformance of silver to artificial influence by some bullion banks. While we certainly agree that a few large players have been allowed by regulators in the US to dominate the hedging or short side of the market, we find that explanation simplistic and lacking. The actual explanation for silver's mediocre performance up to now is actually much more complex, but beyond the scope of this weekend's "fun" look at the graphs. In a nutshell, however, we believe silver's underperformance to gold is more easily explained by the difficulty of most investors to grasp silver's potential relative to gold due to the long, protracted bear market of silver for over 20 years, from 1980 to essentially 2003.

For that long period of time silver was a horrible investment and anyone who invested in silver during those years saw little in the way of reward. For many years, especially in the 1990s and the early part of this decade, the bear market for silver was perpetuated by the industry's own hand via ill-advised forward hedging, leasing and forward selling, feeding the low-price beast with its own flesh and blood. That has indeed changed now.

The period also saw an unnaturally large amount of excess silver metal distributed into the market, government dishoarding and private hoard distribution measured in the tens of thousands of tonnes over 35 years. Years of artificial supply meeting depressed, declining and demoralized investment demand even as the industrial usage of the metal increased and relative annual production suffered. Government dishoarding is over, forever.

It is no wonder that an entirely new culture arose which exploited the lack of demand and artificial supply. A culture in bullion banking where a privileged few profited routinely from repeatedly selling near-dated futures into silver rallies in obscenely large amounts, crushing nascent technical (not real demand-driven) rallies with the weight of their own selling, then covering those short sales in the "manufactured," but all too real carnage.

As the low prices obtained a "life" of their own; as the industry cannibalized itself relentlessly for so long, it was actually sowing the seeds of the next great phoenix-like bull market rush for the tiny silver market. But that's a message for another time, soon, but not today.

When silver falls out of favor, as it did during the long bear market for silver, it seems to do a right good job of it, in other words. For 20 years investors all over the globe were conditioned by a weak silver price and not much joy of ownership. "Silver, who cares?" That sums up the public attitude before this bull market began in 2003. And, even now that attitude prevails among the investing establishment.

That's changing right before our doubting eyes. Well, let's make that right before most people's doubting eyes. Like all major changes in public attitude this one will take its own time, but we believe silver is now in the beginning stages of losing its reputation of being investor "sausage meat".

Slowly, in fits and starts, silver is re-learning, recapturing its historic relationship with gold today. Soon, unless there is another global melt down, the ripples coursing through the amazingly small silver market sea could morph into a popular tsunami, a global viral tidal wave of real, sure-enough demand for physical silver in all its many forms. The kind of real demand that even the best funded, the biggest and the most determined of futures short sellers must inevitably bow to and retreat from.

We believe that both public and institutional interest in silver is finally beginning to simmer, but relative to gold the white metal still has a lot of work to do before this precious metals story writes its final chapter in the years ahead.

Silver has to overcome a lot in order to do that. Recent price history, general apathy, institutional negative bias, producer and bullion bank antipathy and anemic public demand included.

There is one "cure" for that. The cure is demand. Demand begets higher prices. Higher prices for silver actually increases investor interest and that translates directly into even more demand up to a point.

Given silver's relative performance with gold over the past year, we can't be certain that we are seeing a critical mass surge in public and institutional demand yet. Gold has printed considerably higher prices than it did in the May 2008 interim pinnacle, but silver hasn't yet answered in kind. As of December 6, 2009, that is both short-term troubling and long-term intriguing.

As speculators our primary job is to identify obvious and compelling value or liquidity imbalances in tradable markets and then to position as best we can to profit from the inevitable. The market abhors imbalances and constantly seeks to correct them. We believe just such an imbalance is developing in the small, but globally traded silver market.

In this case we believe that we are entering a period where actual investment demand will overwhelm the world's ability to supply the metal for it anywhere near today's prices. We're speaking longer-term of course. Over the short term we cannot yet point to direct evidence that a full-blown silver-tsunami is coming.

But are we "there" yet? Nope, we don't think so, not by a long shot.

We really cannot advise others what to do, but for our own purposes and accounts, we believe significant dips for the second most popular precious metal are for adding to our longer-term minded positioning.

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