The Michael Fuljenz Metals Market Report: September 2011, Week 4 Edition

What a terrible week for investors! We know that gold and silver fell sharply, but so did stocks. The primary measurement of global stock markets is now 23% below its April highs, as measured by Morgan Stanley Capital International's (MSCI) "All-Country World Index." By comparison, gold is just 16% off its highs. The main reason for the global stock market collapse is Europe's banking crisis and America's political stalemate, but the major cause for the collapse of gold and other commodities is quite different.

• Gold 52 weeks ago (September 27, 2010): $1297
• Gold's average price during 2011: $1531.19
• Gold's London Low for 2011: $1316.00 on January 28
• Gold's London High for 2011: $1896.50 on September 5

Last Week In Metals: Almost everything fell last week – stocks fell 6.5%, oil fell 9.2%, gold fell 9.6% and silver fell over 20%.

Why the Rapid Decline in Gold and Silver?

The collapse of gold and silver last Thursday and Friday (continuing on Monday) was instigated by fears of a slowdown in global growth, led by China, and hence a slowdown in the demand for base (industrial) metals for manufacturing, and gold demand based on the rapid growth of China's middle class and their hunger for gold. Since many of gold's new investors got on board through "paper" vehicles – mainly the gold exchange-traded funds (ETFs) and futures contracts – they were the first to head for the exits. Many hedge fund managers began unloading their gold ETFs and futures contracts, and then the rout was on.

Specifically, gold investors ran for the exits after Thursday's preliminary report from HSBC, the Hong Kong bank, which said that China's Purchasing Managers Index (PMI) fell to 49.4 in September (any number below 50 signifies contraction). But the authors of the report also said that China's GDP growth is still 9%, slowing to 8.5%, the highest economic growth rate in the world. Separately, the IMF also predicted that global growth would stay around 4% for all of 2011 and 2012, hardly a major slowdown. Besides, slowing demand for industrial (base) metals should not impact China's love affair with gold.

Then, late Friday, after the major damage was done, the Commodity Exchange (or COMEX) once again raised margin requirements on gold, silver and copper contracts, forcing some investors to run for the exits on Monday morning. Initial requirements for gold's nearby (benchmark) contract were raised 21.4%, from $9,450 to $11,475 per contract. The "maintenance margins" (to hold the position) were also raised 21.4%, from $7,000 to $8,500 per contract. Silver's contract purchase margins rose 15.6%, but from a higher base level, requiring $24,975 per contract vs. $21,600 previously.

When these rules kicked in on Monday morning, a lot of "weak" holders were forced out of the market. Gold touched $1535 in early trading Monday, while silver careened down further on Monday's opening, bouncing off a low of $26.15, its lowest price since last January. Since the opening, however, prices have recovered.

Where Did the Money Go? To Stocks, or Bonds, or Cash?

It's important in times like this to remember that, as of Friday's close, gold was still up 17.6% for the year, while stocks are still down by almost 10%. The decline of the stock market is perhaps the biggest "upset" in the financial universe. This year is supposed to be the "sweet spot" for stocks. In all previous third years of a four-year Presidential cycle (like 2007, 2003, 1999, 1995, etc.), dating back to the 1930s, stocks have risen in EVERY third year of the Presidential cycle since 1943. Stocks have risen especially strongly after a dramatic reversal in Congress during the mid-term elections (like 1994). Last year's mid-term election results were nearly as dramatic as 1994, but 2011 does not look a bit like 1995 for stocks!

If the gold money didn't go to stocks, where did it go? It went mostly to zero-yielding cash. The selloff of gold last week was a panic "dash for cash." Investors sold their gold and silver because they needed the money, for the most part, or were choked out by the new margin requirements. Many hedge funds were unloading their "paper gold" (ETFs) in a panic rush to the exits. These gold and silver ETFs were some of their best-performing investments over the previous months and years, so they took profits. Some sold gold and silver ETFs to meet margin calls on their other investments during a particularly terrible stock market day last Thursday. Some European banks needed to sell gold to meet minimum quarter-ending cash requirements. Some took profits to dress up their quarter-ending accounting. Then, the "momentum players" just piled on, following the crowd. The good news is that the cash is in the bank, ready to act.

Is the Gold Market Rigged?

Last Friday's massacre of gold, silver and copper futures contracts was another indication that some powers in the financial world don't care for the volatility or competition of precious metals. Besides the CME's margin-raising requirements, we received some other new indications last week that governments maybe trying to limit the participation of their citizens in various gold and silver markets.

Some disconcerting examples:

• According to Barron's, Austria just adopted a policy of limiting any individuals' gold purchases. They got this story off the Commodity Online service, as reported by the TIS Group. According to other sources, this was a fairly high-level limit of 15,000 euros (about $20,000), and it was aimed at large-scale money laundering across borders, not a major concern for small investors.
• Now, we hear that France is installing a much tighter restriction of 450 euros ($600) per cash-for-gold purchase. According to the French government Web site, as of September 1, 2011, all purchases above 450 euros must be handled by a traceable credit card or bank wire transfer.
• Also, when Switzerland first announced it would back the Swiss franc with gold, their currency soared. When the Swiss realized they were pricing their exports and tourists out of the market, they announced a cap on the franc. Shortly after that news, gold dropped $50/oz within seconds.
• By contrast, in China, the Shanghai Gold Exchange said on Friday that it will expand (open up) both the upper and lower trading limits for its silver contract. This does not impact gold directly but it shows how popular the metals are in China, where you can find gold vending machines on a popular shopping street in Beijing. According to the World Gold Council, Chinese demand for gold represented only 7% of global demand in 2002, vs. 21% of global demand in 2011.

In general, Asian countries are lifting restrictions for gold and silver buyers, while Europe is trying to crack down on gold investors. Governments can try to manipulate gold, but they will fail in the long run. Over a decade ago, many central banks began unloading their gold to keep the price down, but that backfired. Instead, these central bank sales took a major supply "overhang" off the market, so investors started buying gold. In 2002, central banks SALES represented 15% of 2002's total new supply, and gold rose. By comparison, in the first half of 2011, central banks BOUGHT 9% of global supply and gold still rose.

The Fundamentals are Still in Place for Precious Metals vs. Paper Investments

The federal government's fiscal year ends this Friday, on September 30. Congress is threatening once again to shut down the government. Annual current federal deficit, well over $1.5 trillion, is 10 times what it was in 2007, at $150 billion, and there is no relief in sight. Governments typically would rather inflate the money supply than reasonably cut benefits, such as Social Security or Medicare, and reasonably adjust taxation.

The long-term fundamentals in favor of gold have not changed. The recent correction is our first major decline in years. Courageous investors will get on board, while those who wished for a lower price will be suddenly skeptical. We must remember that every great buying opportunity looks like a panic selloff.

For those who don't yet own gold and have been moaning about how high the price is, now is the time to get into the market. An old Chinese proverb says, "The best time to plant a tree was 20 years ago. The second best time is now." For gold, the best time to buy was a little over 10 years ago at $255 per ounce in the spring of 2001. The second best time to buy is now, after a $300 per ounce decline from its peak.

Would The U.S. Government Consider "Gold Confiscation" Again?

I am increasingly asked this question by collectors, investors and other dealers at conventions and and press interviews. Could the government "confiscate" our gold again? My answer has been "while anything is possible, confiscation is not probable." Today's gold investors are nowhere near as "docile" as most Americans were in 1930s. Many gold owners today would resist any attempt by the governments to seize their privately-held gold.

In this week's Metals Market Report, I briefly address new gold-buying restrictions being imposed in France and Austria. It is important to pay attention when any restrictions on purchasing gold are implemented worldwide. Some government representative could "run with it" and not understand the potential for unintended consequences.

We always pay close attention to any potential legislation which could harm our business. For example, my involvement this year with the Texas legislature helped prevent the business-killing and convention-killing 30-day-hold provision, while also helping legislators retain the legitimate law enforcement provisions and the other consumer-friendly provisions in the new law.

In addition, I believe that the new restrictive actions in European countries could lead to decreased gold coin sales by Europeans to American dealers. This could result in larger purchases of rare gold coins by individuals who believe these "antique" gold coins provide a greater degree of protection from "confiscation" than bullion. The end result could be increased demand, less supply and rising prices for gold coins, especially if a lot more dealers start scaring people to buy antique gold coins with this information. We believe that you should avoid any "scary" dealers, those who try to base their sales solely on scary stories of potential future "confiscation". 

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