Whiffs of Stagflation Send Gold and Silver Higher

Expert David Smith Says a Key Turning Point Has Been Reached

Mike Gleason Mike Gleason
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June 20th, 2014 Comments

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Welcome to this week's Market Wrap Podcast, I'm Mike Gleason.

Well, what a week it's been in the gold and silver markets. The metals are rallying strongly on worsening conditions in war-torn Iraq and the reemergence of inflationary fears here at home.

Coming up later in the program is a revealing interview with analyst David Smith. David puts the spotlight on a key market event earlier this month that almost everyone missed – but that has some major implications for gold and silver prices. Don't miss my conversation with David Smith!

On Thursday, gold surged by $45, propelling prices above the $1,300 per ounce level. Silver added more than a dollar on the day, as prices pierced cleanly through resistance levels. Silver now comes in at $20.80 an ounce as of this Friday morning recording, good for a huge weekly gain of better than 5%. Gold also shows an impressive gain on the week of roughly 2.5%, with the safe-haven metal now trading at $1,312 – its highest level in 12 weeks.

The Platinum Group Metals are also moving to the upside, though with less vigor than gold and silver. Both platinum and palladium are posting gains of 1 to 1.5% for the week.

Earlier in the week, we got data on consumer price inflation that suggests inflationary pressures are growing. According to the Bureau of Labor Statistics, seasonally adjusted prices for beef, poultry, fish, and eggs hit all-time highs in May. Meat prices have risen 8% over the past year, putting pressure on consumers' budgets. Needless to say, wages and salaries are not rising at 8% per year.

In addition to rising food costs, gasoline prices are back on the rise in a significant way, and electricity costs just hit new record highs. Overall, consumer prices last month posted their sharpest increase in 15 months.

Federal Reserve economists have been telling us all year that rising food and energy costs are transitory and attributable to the weather. But to those of us who pay attention to our own food and energy bills, rising prices seem to be a persistent reality.

Of course, the Fed doesn't even take food and energy costs seriously. It excludes them from its “core” CPI inflation gauge!

The Fed on Wednesday lowered its 2014 forecast for the U,S. economy to 2.1% to 2.3% growth. The weakness seen in the first quarter of the year -- weakness that was widely dismissed as a statistical blip – is being acknowledged as a more serious indicator of the economy's health after all.

Economic weakness coupled with rising inflation is known as stagflation – a term you might start hearing more often in the financial media. Stagflation defined the economic environment of the mid to late 1970s. It was an ideal environment for precious metals however. Gold and silver prices entered a mania phase that peaked out in January 1980.

We're a long way from another mania in precious metals. But as of this week, anyway, the stagflation trade is back on in a big way.

The economy isn't strong enough for the Fed to reverse its accommodative policies. Even as it tapers back its monthly bond-buying program, the Fed continues to maintain stimulative near-zero interest rates.

Unfortunately, some leading commentators in the gold bug camp who are prone to making aggressive predictions misread the Fed – and frankly, misled investors. One prominent prognosticator, who often appears on cable TV but who will go nameless here, tied his bullish outlook on precious metals to his insistence that the Fed wouldn't taper….then that the Fed would soon stop tapering and expand Quantitative Easing. Well, that's not going to be in the cards unless a deflationary threat emerges.

Investors who are sitting on the sidelines waiting for the Fed to stop tapering or announce more QE before adding to their precious metals positions are making a big mistake. During the great gold and silver bull run of the late 1970s, the Fed wasn't slashing rates. It was doing the opposite. The Fed kept raising rates, but it didn't get out ahead of inflation until Paul Volcker stepped in and jacked rates up to punishing double-digit levels.

What matters to precious metals markets is not so much whether the Federal Reserve Board is raising or lowering rates in nominal terms, but whether interest rates are running above or below inflation. As inflation rises, and especially as investors come to fears higher rates of inflation, precious metals stand to benefit so long as the Fed remains behind the curve.

Fed chairperson Janet Yellen has repeatedly indicated that the Fed will tolerate higher rates of inflation before it will stop trying to stimulate a sluggish economy and job market with accommodative monetary policy. That's why stagflation could be an emerging mega-trend going forward – one that could be incredibly bullish for gold and silver.

And now for more on the state of the market and what's ahead, let's get right to our exclusive interview.

Mike: I'm joined now by David Smith, senior analyst at the Morgan Report and a regular contributor to MoneyMetals.com. David welcome back, it's good to talk to you again.

David: It's really good to be back Mike. How are you doing today?

Mike: I'm doing great. To start off, let's talk about this major move we're seeing here. As we're talking on Thursday afternoon, gold is up nearly 3% on the day – which is a big, big move for the yellow metal, while silver up nearly a dollar on top of the other gains over the past week.

You've previously referenced the key reversal that occurred early in June that may have set the stage here. Tell us more about that and what's going on here with this big advance in the precious metals this week.

David: Well for those who are into technical analysis a little bit, basically on the chart, if you have a situation where after an extended period of time, prices the next day or the next week in relationship to the previous day or week, if they have a range that is higher and lower than the preceding day or week and then they close higher in the case of a bull move or lower in a case of a bear move, then you have what's called a key reversal.

Sometimes these things happen and it doesn't mean anything but if it happened on heavy volume in the direction of the move, then it's something you really want to pay attention to. This has what happened a couple of weeks ago in the US dollar index and then gold and silver.

The US dollar index had a key reversal downward on heavy volume and gold and silver had a key reversal upward on heavy volume. Not many people caught this. In fact I didn't catch it immediately until somebody brought it to my attention and the reason for that is because it was during a very quiet day where the range had been not all that great.

If you didn't noticed what happened the day before, you wouldn't catch it. Usually these things are very wide ranging days. I started looking at it and the volume supported the move in both gold and silver and the US dollar, it supported the move down.

We wanted to see if over the next days or even the next week or so if the move continued in that direction that I initially suggested and that's what's been happening with gold and silver over the last week moving slowly away from that key reversal day on the upside and then finally today a price explosion.

We'll see if they closes out their week in this regard, but the volume looks very strong and I think we're likely to have a very strong close this week.

Mike: Do you expect to see follow through here? We talked about the technical charts there a moment ago. What are some of the key levels from here that you're paying attention to and what are you looking for in order to confirm that the breakout is in fact real?

David: We have a number of levels above this in terms of resistance in the case of silver. It's $21, $22 all the way up through $26 and then higher, but it would be nice to close above $21, $21.50, $22 in that area and then a consolidation and a holding of say well above $22 because you know it's been down as low as $18-something here for a little.

In the case of gold, it would be nice strong closes above $1,300. The point is beyond the fact of where prices go over the interim is that that now establish what the bears or the bulls would call a fairly good cushion on the downside. The bearish traders are going to have to chew down through that resistance.

Just a week or two ago, they were sitting right in there and now this is quite a bit above where they were and so the bulls have the nod now. What I find very encouraging is that it's highly likely that even if the portion of what we've seen over the last week or so holds on the upside, it really gives even stronger indication that intermediate and perhaps long term lows are in in gold and silver.

Mike: Turning at the Platinum Group Metals, you wrote a great piece earlier this week on palladium that I want to deconstruct with you a little bit. First off, for our listeners, David has been all over the palladium story for well over a year now and has been talking about how the supply deficit would fuel a rally in this metal, which is exactly what's happened over the past year.

We've seen palladium outperform the other metals by a significant amount since the start of 2013 right around the time we first talked to you about palladium on this very podcast. You pointed out that last week's correction in palladium following the South African mining industry labor agreement was going to be nothing more than a blip and a nice buying opportunity. Sure enough that's what we've seen and we've already recovered a good amount of those losses.

Talk about why you felt that way and then what's happening here since that two to three day drop last week.

David: As you mentioned, palladium has been an evolving story. In fact, at the Morgan Report, we've been following this in various forms going to some of the very few properties that are under exploration in the western hemisphere and following the charts on platinum and palladium.

In looking at the supply demand fundamentals that Johnson Matthey and others put out have indicated that we have an evolving and looming shortage of these two metals because there are very few places in the world, primarily South Africa and Russia, that actually produced the vast majority of them.

As you mentioned, I had written a series of articles over the last years. My premise was that even though silver and gold had been in a cyclical bear market within the much larger secular bull market and they have been weak over the last two and a half years or so, platinum and palladium have been grinding slowly higher. And that they were actually strongest of what I call the “precious metals four”.

I truly then even focused more on one of those two PGM metals (Platinum Group Metals), which was palladium. Which my analysis (as well as) other analysts that I follow, indicated that they have even more potential to the upside when the boom will finally get under way.

Because it can be used for many of the same things that platinum can be used for and it's also about $500 an ounce cheaper. It is actually rare and platinum and yet it trades for example now to around $800-and-something an ounce and platinum is around $1,450.

What was really revealing when I got to looking up the longer term charts, I looked at the 5-year price chart to see where the two white metals were in relationship to their five year highs. Palladium has actually challenged its five year highs in the last week before this big drop that we had last week.

Platinum is still about 400 and some dollars below its five year high. Both of these have very bullish fundamentals which really could go on for a number of years before the supply catches up to demand. Of the two, palladium is much stronger from a chart standpoint.

Mike: In terms of the South African Mining agreement or labor agreement that they finally struck, you were talking to me off-air earlier that that is not really going to result in a whole lot. Of course the initial market reaction was the palladium dropped for 5%, but that's still a pretty significant story and they are not out of the woods at all yet with that whole situation with those mines.

David: That is really true and it's the old “buy the intention and sell the news” (mantra). What happened is going on to the strike which actually lasted five months. By the way while this is going on, the deficit that was building up of PGMs that were not being mined was in the order of 5,000 to 10,000 ounces per day.

Finally it was "solved” about a week ago, they came to an agreement with the miners and the price which had been going up in anticipation has dropped over $40 an ounce but that did virtually nothing to have any exchange on the supply-demand considerations which are going to go on for a number of years.

So I looked at it as a potential buying opportunity and what's happened now is that it's trading in that range of where it dropped versus the high. It's still kind of in a lower third of that range and it may take awhile to get back up and establish new highs, perhaps a few days, perhaps a few weeks.

The point being is that it's almost certain it's going to be going higher. We've seen this kind of a move into PGMs on a several of occasions if you look back at charts to go back several years. In their bull trend, they've inevitably pushed on higher. So I think the odds are very good that we will see higher prices over the near term, certainly in palladium, if it moves up to challenge that high.

It was very interesting, I just read this today, but supposedly the miners and the producers achieved the agreement, but already the producers are saying, "Well there are several things here that we had agreed upon that we're just not going to be able to afford to do." I really think that this issue between the miners and the producers is a systemic one.

There's not going to be any solution. In fact maybe no solution because of the dynamic of the way PGMs are currently mined in South Africa today.

Mike: Another thing you noted in your piece was that like silver, palladium and the PGM metals for that matter are mined as a byproduct of other mining. Talk about why that's significant and really a bullish dynamic.

David: This is really interesting. It has, as you said, something very much in common with silver. In the case of silver, something like 60% to 70% of all the silver mined actually is a byproduct of base metal production of lead, zinc, or copper. Some of the biggest producers in the world of silver actually it's almost a byproduct of the other things that they mine.

What happens in a case like this and this is also true of palladium and to some extent platinum is they compose 7% to 12% of the value of the ore that comes out of the ground for their products. If the price would have go up greatly, it still doesn't mean that they're going to necessarily mine a whole lot more copper and nickel because that's going to be determined by their own metrics of demand.

So they're not going to mine a whole bunch more copper and nickel as an example just to get 7% of the value of that in palladium. That's called price in elasticity. That would mean if the price goes up, it doesn't necessarily mean that there will be a lot of supply which will be dug out of the ground to try to chase that price.

Mike: That's a very key indicator for me and a key dynamic for somebody looking at precious metals. If supply is not likely to just all of the sudden get flooded on the market because of that type of dynamic, it's certainly a very, very bullish fundamental.

One of the aspects you talked about in the article from this week was the huge amount of demand that will created for palladium based on the fact that China is starting to get serious about vehicle emissions. Talk about that and the impact it may have on the continued growing demand for palladium.

David: China has incredible problems with smog and with pollution in their biggest cities. In fact, in Beijing, sometimes the sky has so much smog in it that the planes have a hard time landing and it blocks out the sun and of all the health issues that go on with that. That's just one city.

They're taking millions of cars off the road that don't meet emission standards and they're going to be using more platinum and palladium in catalytic converters which are really the only thing that would serve to cut down the smog in the use of those vehicles.

It's my understanding that currently that the palladium and platinum that are used in Chinese vehicle production is something like a third to a fifth of what we use with a corresponding less efficiency, so I'm guessing that they're going to be using more for vehicle as well. That's just as most of the demand for the PGMs today has to do with catalytic convertible use in regular engines and diesel engines.

This is going to keep on growing as the economy grows. That's just one demand element that is getting bigger. You have the rise of the exchange rate of funds which will people invest in the funds, buy shares in those funds, buy physical metal, take it off the market and store it like the silver ETF and the gold ETF.

This is a relatively new phenomenon but there are few ETFs out there for the PGMs and they're soaking up supply like a sponge. In addition, you have more and more people ... and this has been pretty most recognized in China for quite some time in addition to jewelry use of platinum and palladium.
My daughter got married a few years ago and she has a ring that is not made out of gold but it's made out of platinum and palladium. This is becoming more of an interesting thing from a jewelry standpoint but these people are also buying to this in an investment, they're buying palladium rounds (coins) and palladium ingots because they're really as attractive in their own way as holding gold and silver as a precious metal for a long term hold.

Mike: A lot of people that we deal with don't even have enough gold and silver yet and they're not really even thinking about platinum or palladium at this time at least until they've got a stash in the main money metals, but you mentioned in your piece there that palladium's chart could be a real indicator for what's to come in silver. I wanted to ask you about that because that certainly would be of great interest to a lot of our customers and listeners to this podcast.

David: I think it's very helpful because one of the things is that human emotion really doesn't change whether the vehicle was precious metal purchasing or real estate or stocks or anything else. They tend to be investing on emotion even more than reason following the facts.

I believe as the PGM break out gets underway, as palladium makes new highs, and then down the line platinum does the same thing, you're going to see this kind of a rush into the metals and an excessive valuation in metals that's based upon a lot of chasing that goes on by speculators.

They'll eventually push it above fundamental value and we'll see certain chart formations as it makes intermediate tops which is the same thing that's going to happen to gold and silver some years down the line. The thing is for you and I and for the people listening to this interview, I don't think very many of us want to be speculators where we'll try to buy something next week and sell the week later.

Indeed the way to make significant return on your investment to have the best chance is to buy something when it's a reasonable price and hold on to it for an extended period of time. Because bull markets don't just usually happen in four or five days and then they're over.
We wouldn't want to be in something like that. Anyway it's straight up and straight down a few days later. They develop over weeks, many, many weeks to even get started and then they have a break out. When they have a significant break out that's confirmed by new higher prices, they tend to go on for months or even years.

That's the thing we're looking at I think for all the “precious metals four” is a very significant rise in price over a series of years rather than something where we probably want to be out of this by August. That is where the people who like us who are not really speculators but rather investors and also seeking to preserve and protect our wealth not only for insurance, but assurance, then this is a type of market that we really want to pay attention to in our own financial lives.

Mike: Well it will certainly be interesting to see what happens here at the remainder of the year. A lot of precious metals investors have been pretty worn out by what's happened the last several years, but I guess the main advice there is just to hang in there, better days are ahead of us and you'll be glad you kept your nerve and hang on to your position versus selling it at low levels.

David, fantastic insights as always and thanks very much for joining us again. I hope you have a great weekend and we'll catch up with you again real soon.

David: It's been great speaking with you Mike. Have a good week.

Mike: For those who haven't yet signed up for the Morgan Report, we have a special offer for Money Metals Market Wrap Podcast listeners, the ability to get a no-risk trial of the Morgan Report newsletter plus free silver. For any listener who signs up for one of these refundable subscriptions today. Money Metals Exchange will ship you a free one ounce Silver Eagle.

The quality of information in the Morgan Report is second to none for anyone investing in, or just thinking about investing in the precious metal sector. To take advantage of this special deal, please look directly below today's podcast.

Well that will do it for this week. Thanks again to David Smith. Check back next Friday for our next weekly market wrap podcast. Until then, this has been Mike Gleason with Money Metals Exchange, thanks for listening and have a great weekend everybody.

Mike Gleason

About the Author:

Mike Gleason is a Director with Money Metals Exchange, a precious metals dealer recently named "Best in the USA" by an independent global ratings group. Gleason is a hard money advocate and a strong proponent of personal liberty, limited government and the Austrian School of Economics. A graduate of the University of Florida, Gleason has extensive experience in management, sales and logistics as well as precious metals investing. He also puts his longtime broadcasting background to good use, hosting a weekly precious metals podcast since 2011, a program listened to by tens of thousands each week.