How will gold and silver react to a second global financial crisis?
Posted on 20 October 2010 with 8 comments from readers
ArabianMoney has been pondering how precious metals would respond to another global financial crisis for well over a year. It was therefore instructive yesterday to see how gold and silver prices responded to the sharp stock market sell-off that followed news that China was hiking interest rates and demands from some bond holders for the repayment of US mortgage securities.
This could be the start of another global financial crisis, or not. Certainly these two black swans dropped out of the sky to upset the Fed put on equities. But how did gold and silver respond?
Gold and silver fall
There was an immediate reaction with the biggest pull back in precious metals in months, and bonds edged higher and the dollar gained in value. This is what we have been anticipating in this column for months but the really big unknown is how low gold and silver could go if this sell-off gathers momentum.
In late 2008 those who held onto gold and silver and followed the advice of gold bugs like Jim Sinclair took a big hit. The argument against that happening again is that there is less leverage in the precious metals’ market today and there is higher demand for the metals. That said hedge funds are more involved and that usually a bad sign for volatility.
The ArabianMoney view has thus been to expect a pull back in precious metals in a second global financial crisis but not one as big as 2008, and with the prospects of not only an equally big recovery but much higher upside in prices in the immediate aftermath of the storm.
Trading positions
Traders should sell now and buy back when they consider the storm at its worst. Less confident souls should just hold on through a crisis, just in case it does not materialize, and if they have the stomach add to positions when things look worst.
For the medicine that will be used to cure the next crisis will be highly inflationary, and gold and silver will be the best financial asset class to catch that inflation. Indeed, the proof is surely the increase that we have seen in precious metal prices since the bailouts of the first financial crisis. You are only looking at more of the same thing.
8 Comments posted by readers:
And just like the short banks argument, this is assuming that the administration would _allow_ dow to tank.
Stop and think for a moment what this option looks like. DOW/S&P indexes (for which mom and pop look to as a measure of economic confidence) tank for 5 straight days at 200+, sentiment indicators very negative, vix soars and the most powerful emotion would again rule the world. March 2009 all over again with a more downside.
This is not an option.
BTW: thought provoking articles, keep it up!
Ed Note: Do you really think they chose it in March 2009? They are not in control, wise up!
The Imperative from the Obama Administration:
No doubt, the Obama administration and the US government, the FED and the Treasury Dept. are extremely active in keeping the comatose US stock market alive (yes, I’m aware that the FED isn’t really a government organization, but it is highly political, and pays homage to what the US President wants). A discussion with almost any trader on the floor can confirm this.
There’s a Limit to Manipulations:
But there’s a limit to how much manipulation the US government can do; from their perspective, they’ve got to continue to manipulate at all costs until the mid term elections. So when will we reach “the tipping point?” Who knows, but it can’t be very far off.
Trading Positions: How Low Will Gold Go?
Since mid September, I’ve sold off about one third of my precious metals positions including gold and silver mining stocks. I don’t regret that decision, even though I’ve left about 3 – 4% on the table (miniscule, in comparison to the gains). How low will gold go in a big correction? Dunno for sure, but I suspect we may see a correction of about 10% in gold, and much more than that in the general stock market.
And I have to agree with Peter on his prediction that gold will recover quickly after a big correction.
Wikipedia ‘Washington Agreement on Gold” which keeps getting extended.
I have the same concerns but I am not selling I am not much of a trader however I might after a big fall for gold borrow Euro and buy more
“Ed Note: Do you really think they chose it in March 2009? They are not in control, wise up!”
POMO team was not yet mobilised March09, caught unawares and thats why we are where we are now. It will not happen again though, the thought of a global depression is just too scary, and violent – I kinda agree with the fed on that point.
Cheers!
@ nigel:
While your comment is true regarding the FED’s POMO, there’s a limit to how much manipulation they can get away with.
For example, folks outside the US (e.g. China) knows the extent of manipulation, and they (as well as many other Sovereign nations/ funds are monitoring it very closely. One of the most powerful “financially-related” forces in the world is the global bond market. Think of the implications of a global US treasury bond ’sell-off’; this is what scares the hell out of Bernanke.
@obewon good point, hadn’t thought about it from that aspect. Does this mean that bonds can tank in value with yeild at zero at the same time?? Is there a historic precedent for this? I thought there was an unbreakable inverse relationship between price/yeild…
Great stuff!
@Nigel:
At the present time, the bond prices are very high, while the yields are very low; if yields begin to rise suddenly, then yeah, the bond prices must fall since this inverse relationship is, indeed, unbreakable . . . and all of this is happening while: a) the FED is printing money furiously while manipulating the markets, and b) the US is experiencing a deflationary period (which, from the FED’s perspective, is considered to be an “evil” thing).
I don’t know of any historical period that is the same as the one we are currently in, but there have been many periods in recent US history where the bond market suddenly tanked. One example, from recent memory was in 2003. Go here for info:
http://www.gold-eagle.com/editorials_03/chapmand073103.html
Looking ahead, there are many knowledgeable bond analysts who believe that there will be a severe bear market in bonds (i.e. interest rates rising suddenly, while their prices fall suddenly) in the near future. Then there are a few others who admit this will happen, but that this catastrophic event is many months away, because we’re still in a severe deflationary period.