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Gold & Silver Strong – Banks & Stocks Scary

Gold and silver stole the show in the first half of 2016. Can metals investors expect an encore performance in the second half? It is certainly possible, but the markets will need some help. The trick will be holding onto the speculative interest.

Metals spent 5 years mired in a backwater of underperformance. That began to change at the beginning of this year. Gold and silver made it back into the headlines and back atop the charts of best performing assets. The success drew a flood of capital back into the futures markets and into metals ETFs. It is these speculators who provide the fuel for big moves in prices.

Metals bulls need this crowd to keep piling in if they are going to get a second half performance that matches the first. It goes almost without saying that another geopolitical event – such as Brexit – can ramp up interest in precious metals as a safe haven. But that sort of market-shaking event is unpredictable by nature. It can only be said that we live in volatile times and there are some fuses burning around the world.

There are a handful of specific catalysts worth keeping an eye on.

Gold Bull

The first is obvious in a way, but bears noting. It’s price action. Higher prices tend to create a “virtuous cycle” leading to further rises.

For starters, positive performance and good-looking technicals draw speculators like honey. Many traders, and trading algorithms, are scouring the charts in different markets and looking for momentum they can capitalize on. Any break above an important resistance level – such as $20.50 for silver – has the potential to entice a new wave of speculators.

Higher prices also put pressure on short sellers. It is important to remember there are two parties to every futures contract. One betting on higher prices and the other betting prices will fall. The year so far hasn’t been much fun for the latter group, but with record open interest in futures, we know they haven’t given up.

If prices move higher in the coming months, we may see some shorts capitulate and start buying to cover and exit their bad bets. But it needs to be said that much of the short interest is held by the bullion banks. They are a notoriously tough adversary.

The Banking Sector Looks Like Trouble

European Banks are also worth watching between now and year end. There is smoke, so we could get a fire.

The IMF recently declared Germany’s Deutsche Bank the single greatest risk to the global financial system. The bank’s share price reflects deep concerns over its solvency. DB is loaded with non-performing loans, massive exposure to derivatives, and huge litigation expenses related to fraud and cheating. Investors have been aggressively selling for 2-½ years, and the shares now trade nearly 50% below the lows put in during the depths of the last financial crisis.

Credit Suisse isn’t in a lot better shape based on the way its share price is performing. And then there are the Italian banks. William Watts with Marketwatch says “It wouldn’t be summer without Europe threatening to upend global financial markets.”

Italian officials proposed a bailout, but they are running afoul of European Union rules that restrict propping up banks with printed cash or taxpayer money. The clock is still ticking. One should never underestimate the commitment of central bankers when it comes to bailing out their brethren in the private sector, but it is getting harder to sell repeated rounds of banker welfare in Europe. If Greece has taught Europeans anything, it’s that overleveraged banks and overleveraged governments are financial black holes.

The failure of even one modest-sized European bank will send ripples through the world financial system and would likely drive significant safe-haven buying in metals. If a monster like Credit Suisse or Deutsche Bank were to collapse, look out!

Stock Market Valuations in Nosebleed Territory Suggest Correction Near

Lastly, we suggest keeping an eye on U.S. stocks. Precious metals were big beneficiaries during the selloff in stocks both as the year opened and again following Brexit. Investors looking for safety sold stocks and bought metals.

Both prior stock market corrections were short lived, and the major indices now trade at all-time highs. Valuations are widely acknowledged to be at nosebleed levels versus historical norms. They certainly aren’t supported by company earnings which have been mixed. With stocks in bubble territory – that is to say rising almost relentlessly despite the lack of solid fundamentals – a major correction is possible at any time.

Bull Market Bubble

That said, we are coming up on a presidential election. And there is good reason to think that central planners at the Fed are anxious to keep the economic recovery meme alive until after the election.

They may even be buying stocks.

Individual investors have been fleeing the equity markets in droves and that begs the question: who exactly is doing all this aggressive buying? One big source of demand comes from corporate share buybacks. If in addition the Fed is intervening in the equity markets, it could be a very long time before any major correction.

Some respectable gains in metals are a good possibility between now and year end. There is good evidence that we have entered a new bull market cycle and those tend to last years. But to get another 6 months of spectacular gains, we’ll need something powerful to draw the next wave of speculative demand.

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