Gold and silver: you ain’t seen nothing yet

2012-JUN-28

More so-so price action in precious metals over the last two days, with gold and silver still struggling for near-term direction in the face of continuing European political uncertainty. Trading volume in Comex gold futures continues to decline, as often happens during the summer months. On top of this – though it will come soon – the US Federal Reserve is still sitting on its hands with regards further monetary stimulus. In combination, all of these factors are causing the continuing consolidation in precious metals.

How long such consolidation will last is the million-dollar question – and if this author could answer it, he’d be sitting on his yacht in the Bahamas instead of hunched over his computer writing this market update. Nevertheless, there are certain indicators you can look at that give clues. First and most importantly: have the fundamental reasons for owning gold and other precious metals changed recently? Have central banks suddenly “got religion” and vowed to protect the value of the currency they issue? Are governments succeeding in shrinking their deficits? Are savers now being offered real returns on their capital? Has stability and soundness been restored to the banking system?

The resounding answer to all of these questions remains “no”. Moreover the Fed, European Central Bank, Bank of England and others remain committed to devaluing their currencies in order to ward of deflation. This is a simple point we keep banging on about at this blog, and one others such as the Cobden Centre’s John Butler have examined in detail. In a fiat currency system, the choice between inflation and deflation is a policy decision.

Deflation would be the natural order of things if we were on a gold standard, and we would have seen big drops in general prices in many countries following the 2008 panic if market forces had been allowed to reign. But as far as recessions and depressions are concerned, governments are not in the business of just sitting back and watching creative destruction of the market take effect.

The problem is that in pursuing ever-more aggressive methods of money printing, central banks are steadily chipping away at people’s faith in currency. The nightmare scenario is what James Turk and others such as JSMineSet have discussed over the years: that we eventually reach a point where people’s faith in a currency literally evaporates overnight.

Gold and silver may be tranquil for the moment, but do not let this kid you into thinking the party’s over. You ain’t seen nothing yet.