Best of the Week

Gold and Silver Plunge, The Final Part of The Downswing?

Commodities / Gold and Silver 2010 Jan 21, 2010 - 02:20 PM GMT

Although the picture this past year has been bleak, there are plenty of bright spots around the world.  We touched on this point in one of our recent essays, and we would like to elaborate further. In economic terms, this decade was very kind to countries like China, India, Brazil and Indonesia.  If you exclude the U.S., they also happen to be the four most populous nations in the world (The U.S. ranks third.) Together, they account for more than 40 per cent of the world’s population. All four countries have made remarkable progress this decade in terms of economic growth and standards of living.

In any given year, an extra percentage point of economic growth may not seem like such a big deal.  However, if taken over a longer period of time, the difference between an annual growth of 1 percent and 2 percent will determine whether the standard of living is doubled every 35 years, or every 70 years. A 5 percent annual economic growth means that living standards will double about every 14 years. By the way, the above calculations can be easily approximated by the "rule of 70" which says that if you want to know how many years it takes for the GDP to double you take 70 and divide it by the growth rate (in percentage terms), for instance 2 percent growth means doubling the GDP in 35 years, as 70 / 2 = 35. Although this may sound complicated, the true calculations behind this rule of thumb are not that complex - you will find more information here.

Moving back to the regular part of the commentary, Indonesia had solid economic growth during the entire decade, mostly in the 5 to 6 percent range annually. Brazil also had a good decade, with growth at times exceeding 5 percent a year.  China and India have made extraordinary strides.

It seems that the US is losing its privileged place in the world, taking a step backwards, while some of these countries, especially China, are taking a giant leap forward. It was White House Chief of Staff Rahm Emanuel who said about a year ago: “you never want a serious crisis to go to waste.”  He was on to something. In some cases, the catalyst for setting these emerging powers on the road to economic reform and national resurgence was fiscal and foreign exchange crisis.

For example, in 1978 China was desperately short of cash and Deng Xiaoping was more willing to liberalize the Chinese economy with ideas that promised to deliver faster growth and higher revenues.

India embraced economic reform in 1991 when its government found itself with foreign reserves that were worth just two weeks’ worth of imports. The Indians had to send gold to London to secure an emergency loan from the International Monetary Fund.

Manmohan Singh, then finance minister and now prime minister, urged his colleagues to “turn this crisis into an opportunity to build a new India”. The rest is history.

The wealthier that countries like China, India, Brazil, Russian and Indonesia will become, the more customers there will be for new innovations and products. Also, from our point of view, there will also be more customers clamoring for gold. The verdict is still out on how this past decade will be remembered in history. It all depends on where you lived.

Moving on to the technical part of this week's commentary, let's begin with gold, which has just moved considerably lower.

Analyzing the long-term chart before providing short-term details allows us to keep the proper perspective, and helps out to filter out the noise. This time, this approach lets us see that gold is still above its long-term trend line, and the history suggests that it will need to move below it before the bottom is put. Please note that it was the case during the March-April 2009 downswing and the June 2009 one - we have marked the analogous trend lines with black thick lines. Naturally, the question now is whether the bottom has been already put or not.

The above chart suggests that gold may need to move lower before rising once again. The Relative Strength Index is visibly above the 37-38 area, which confirms the above assumption. The same can be said about the Stochastic indicator - is it far from the blue horizontal line. If history is to repeat itself once again, the Stochastic indicator is likely to move below the 20 level and hit the blue line once again. Consequently, we will have a particularly favorite buying opportunity in the yellow metal.

The analysis of the silver market confirms points raised earlier - namely, the second stage of the correction appears to have just started.

The long-term picture did not change since last week. In the previous Premium Update we wrote the following:

The tendency for the silver to correct in more than one stage is even stronger for the white metal than it is for the yellow one, especially after big upswings. This has a lot to do with the fact that silver is generally more volatile than gold (…). The point here is that what we've seen up to date is most likely just a first part of the decline. We doubt that the second part would take us much below the recent low, but it appears likely that it will take some time (a week or a few of them) before the final bottom for this decline is put.

Please take a look at the situation in the Stochastic indicator. During past corrections it formed some kind of double-bottom, after which it rallied to/above the 80 level only to correct soon after that. This is where we are today - at the moment Stochastic indicator has just moved above the 80 level. Should the history repeat itself once again, silver may move lower soon.

Based on silver's performance during similar corrections, it currently seem that it may need to move lower - to the \$16 level in the SLV ETF - before it moves higher once again.

Silver has indeed moved lower during this week, but it is still above \$17, suggesting that the bottom has not been put yet. Short-term chart provides additional details as far as timing is concerned, but we will leave this part of the analysis to our Subscribers.

Summing up, the precious metals market has been moving rapidly lower in the past few days and it seems that PMs are close enough to the bottom to make long-term purchases right away. Please note that by buying now, you are definitely not buying at the top.

As far as the short-term is concerned, we believe that PMs may stop declining for a few days, because the previous bottom has just been reached (at the moment of writing these words), which provides short-term support. However, after a few days of pause, PMs may need to decline further before the final bottom is put. More detailed analysis (almost 4x bigger than this essay with many additional charts) is available to Members of the Premium Service.

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Thank you for reading. Have a great and profitable week!

Thank you for reading. Have a great and profitable week!

Editor
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