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Fed Mind Games Get Tricky...

But THIS Fundamental Puts a Floor Under Prices

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Announcer:

Welcome to Money Metals Exchange's weekly market wrap podcast. Helping precious metals investors during these treacherous times. Now, here's this week's market wrap with commentary and analysis from the fastest growing precious metals dealer in America, Money Metals Exchange.

Mike Gleason:

Welcome to this week's market wrap podcast, I'm Mike Gleason.

Well, the Federal Open Market Committee gave investors a treat at its meeting on Wednesday by leaving its Quantitative Easing program unchanged. But on Halloween, precious metals bulls got a trick, as gold prices fell 1.5%, while silver lost 3.6%.

Even though the FOMC statement indicated that the economy was too weak to begin tapering QE, it also included comments which investors interpreted as being more hawkish than expected. The Fed noted some improvements in the economy. If confirmed by data released in the coming weeks, the Fed wants us to believe it will withdraw some of its $85 billion per month in stimulus.

And that explains yesterday's market action. Whether the Fed is just playing more mind games or is actually moving closer to taking some sort of substantial action remains to be seen. In the meantime, the U.S. Dollar Index rallied back above the 80 level as metals prices fell.

As of this recording on Friday morning, gold prices are kicking off the month of November with a continuation of yesterday's mini-selloff. It has given back a few more dollars but is still holding above the $1,300 level at $1,315 per ounce. Silver is flat and is still hovering just below $22.00 per ounce, coming in at $21.93.

As much as markets now are being driven by Fed policies and investor expectations of future Fed actions, what about the supply and demand fundamentals for precious metals? Yes, the things that metals analysts have traditionally focused on still matter! Things like how much it costs on average for miners to produce an ounce of gold.

When gold prices are high relative to mining costs, that's one indicator that gold might be fundamentally overvalued – or at least it means prices carry some downside risk. By contrast, when spot prices are close to the actual costs of production, investors can buy bullion coins, rounds, and bars knowing that prices are near something of a fundamental floor. Gold won't get produced if miners can't do so at a profit.

Mining costs could theoretically drop in a deflationary environment, but the trend over the past several years has been one of rising costs. And, of course, the Fed remains committed to staving off any kind of sustained deflation. In a world awash in debt, central bankers are deathly afraid of a shrinkage in the money supply – and they certainly don't like to see prices of things go down.

In 2003, gold production costs averaged less than $200 per ounce. By 2012, it cost an average of just over $1,100 to bring an ounce of gold to market. And that's just average. Some mines can't produce gold with any profit margin to spare at today's prices. This explains why mining stocks have gotten hit so hard over the past couple years.

The silver lining is that these brutal conditions for the mining sector present a great opportunity to buy physical precious metals near their actual costs of production. Historically, gold prices have traded at an average premium of 2.1 times gold's production costs. Assuming an average production cost of $1,100 per ounce – and all-in costs are now probably a little higher than that – a return to spot prices being 2.1 times production costs would imply a gold price north of $2,300.

This $2,300 per-ounce price target assumes no further cost inflation spreading through the mining industry. And it assumes gold doesn't enter overvalued territory.

We fully expect gold will become fundamentally overvalued by various measures by the time the next major cyclical peak arrives. Markets never stop and settle at fair value. They tend to overshoot both on the downside and the upside as momentum feeds on itself.

For now, the bottom line is that downside risk in gold appears limited at these levels. Upside potential is great – even using very conservative assumptions. The same can be said for silver, which is produced largely as a byproduct of gold and base metals mining. Where gold goes, silver can be expected to follow, but in an amplified manner.

Well that will do it for this week's market wrap podcast, thanks for listening. This has been Mike Gleason with Money Metals Exchange reminding you that remain fully committed to getting you the most value for your depreciating dollar... with speed, with accuracy, and with top notch service. Have a great weekend everybody.

Announcer:

Thank you for joining us for this edition of the Money Metals Exchange Weekly Market Wrap. Be sure to come back next week, and don't forget to subscribe to our weekly podcast through iTunes. For answers to all of your questions, or to discretely and securely buy or sell gold or silver coins, bars, and rounds, call 1-800-800-1865. Our knowledgeable and no-pressure specialists are standing by between 7:00 a.m. and 5:30 p.m. mountain time, Monday through Friday. Visit us at www.MoneyMetals.com or call 1-800-800-1865.

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