House Mountain Partners

Is This the Turn in the Metals Markets?

Chris Berry

By Chris Berry


  • Precious metals roared higher yesterday.
  • This was presumably due to a confluence of events including Iraq dissolving into civil war, more unrest in the Ukraine, and Fed Chair Yellen's dovish remarks regarding keeping rates low for an extended period.
  • Lest we get too excited, base metals were left in the dust and bond yields fell precipitously.
  • These two reliable indicators of growth (and inflationary expectations) lead us to believe that what happened yesterday was either short covering or a profit taking opportunity and nothing more.



Plus Ca Change....

I'll admit to being surprised at the move in gold and silver yesterday. It's almost as if people were looking for an excuse to take metals prices higher. Finally, a confluence of geopolitical and economic events conspired to push gold and silver to intraday highs of $1,321.50 and $20.91 respectively. What's more, many of the mining and exploration plays that have seen value destroyed, caught the tailwind and "popped".

Fed Chair Yellen talked about rates in the US remaining at low levels for the foreseeable future once QE ends and this put pressure on the US Dollar and convinced market participants to run into the precious metals. The USD Index in 2014:

The dominant question in the mining space today is "what will mark the turn in the cycle"? Given yesterday's events, this question is more relevant than ever. The deal between First Quantum (FM:TSX) and Lumina Copper (LCC:TSXV) for roughly $470 million on a fully diluted basis is also a welcome sign of life as much of the sector continues to contract and consolidate. Despite this, we still see very little evidence of a convincing turn. Why?

Yesterday's rally was narrow in focus. Aside from gold and silver roaring higher, bonds also rallied with the US 10 Year yield falling to 2.50%. The base metals, including copper, lead, zinc, and nickel barely budged. If the metals cycle had definitively turned, we would expect to see a more broad-based rally.  

Second, if inflation really were an issue worrying the Fed and other global central banks, wouldn't we see higher, rather than lower, yields? After Federal Reserve officials have flooded the globe with US dollars and expanded their balance sheet to $4.3 trillion, all we have to show for it is a 2.50% yield on the 10 year.

The broad equity markets, hovering near all-time highs, barely budged yesterday as well.


Success at the Fed

The Fed has succeeded at generating inflation - but it is not the inflation statistic that they measure. This is a major dilemma. Should inflation really "show up" in the official government statistics, will policy makers be able to drain the system of excess liquidity fast enough to corral runaway price increases? With QE slowly coming to an end, what other tools can the Fed leverage to support what is realistically a stagnant economy? Remember, Q1 2014 GDP in the US was NEGATIVE. I doubt the Fed will very easily be able to raise interest rates anytime soon in an economy still struggling to find its footing in an overwhelmingly disinflationary environment. To be fair, recent economic data looks more promising and so the ability of the US economy to grow at or above its historical trend growth rate (escape velocity) will be a key metric to watch in the second half of 2014.

Anyone who has been to the grocery store lately can see the effects of QE. The intended wage inflation is notably absent with companies intent on using excess cash on share buybacks and dividends rather than investing in organic growth through cap ex. We are in a world of faux earnings in the equity markets. Look at the rise in livestock prices in recent years relative to a flat USD and falling personal savings rate in the US:

And here is wage inflation in the US since the 1960s:

Given recent upheaval in Eastern Europe and the Middle East, the price of oil has spiked to $115 per barrel (Brent). The price of crude oil makes up 71% of the price of gasoline.  Once this filters through to higher gasoline prices, you're looking at a scenario where the engine of growth in the West - the consumer - becomes at risk. The US consumer historically is responsible for 69% of GDP. Since 2009, this percentage has fallen to 25% - a telling trend.

Yesterday was a welcome change in a market suffering from a lack of volatility and conviction in general. The S&P 500 index hasn't moved more than 1% either up or down for 44 straight days according to Bloomberg. This wasn't the turn many are anticipating, but is a welcome opportunity to take profits.

Silver rose 4.9% yesterday. Few people realize that in 2013 there was a reported deficit of 113 million ounces of the devil's metal.  In 2013, investors purchased almost 500 million ounces when you combine coins and bars (245 million ounces), silverware (50 million) and jewelry (almost 200 million). Maybe the markets are waking up to supply demand realities.

Most investors have considered gold and silver dogs with their best days behind them. Yesterday the futures market opined, worried about latent inflationary expectations.  The gold and silver futures market was the tail that wagged the dog. Speculators in precious metals barked long and loud.

We are of the opinion that an economic recovery is still slowly materializing, but when it comes you are going to see more volatility like we witnessed in the precious metals yesterday.








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