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Wednesday, April 17, 2013

Why Did Gold & Silver Fall?

It has been fascinating to watch how the precious metals decline has been viewed by different groups within the financial markets. The first group, which is the largest and makes up the mainstream media, feels that the gold "bubble" has finally popped and investors should now focus fully on purchasing the best financial assets money can buy: stocks and bonds.

Financial advisors do not make money if investors purchase gold. The average person would either call a bullion dealer to buy physical metal or purchase through a Sprott like fund. In either case, the advisor and the company they work for are not receiving their mutual fund management fees for this investment. 

The other part of this group is the mainstream media financial networks. If you have spent more than 30 minutes watching these channels you will notice their advertisements are composed mainly of the financial groups I just mentioned. The guests on their shows, which advise you to purchase stocks and sell gold, work for these companies above.

Think about sitting down with a real estate agent to have a discussion on what you should do with the remaining $300,000 of your retirement money. You are deciding whether to purchase a home, or put the money into stocks and bonds. Which direction do you think the real estate agent will nudge you? What if that same conversation took place with your investment advisor?

I left the real estate industry in mid 2007 because at that time I felt (after reading tomes of information) that real estate prices were going to fall very far for a very long time. It was my job at that time to convince people to purchase a home (which I relied on to put food on the table and a house over my head), and I felt in my heart doing so would hurt them. So I quit.

This same logic applies to gold and silver. I think that when this secular bull market in precious metals ends, it will culminate in a mania. At that point you will have many people brought on the mainstream financial news networks to give you their reasons why gold is going higher. Some of those people will be bullion dealers. The more precious metals people purchase, the more money they make on every commission. So would it make sense to listen to a bullion dealer when metals enter a mania? Of course not.

If someone makes their living selling a specific commodity (stocks, bonds, real estate, gold, cars, or boats), it makes no sense to take their advice on what you should buy. Will a sales rep at a Ford dealership give you a perfectly honest comparison of his Ford vs. the Honda across the street? Of course not.

The second camp in the gold and silver markets are the conspiracy bulls (some of which sell gold and silver as I just discussed). They believe that gold and silver rise based on fundamentals and they fall because of government manipulation. They believe that the Federal Reserve was the reason why gold and silver fell this week. 

The entities that took down the gold and silver paper markets on Friday and Monday care very little about what the government or the Federal Reserve want. There is no conspiracy. They are professionals. They are cold blooded killers, sharks in the water, that care nothing about the government. These entities have the ability to dump massive amounts of paper shorts onto the market, almost always in carefully calculated illiquid periods where they know they can make the price waterfall lower. Once it begins to fall it triggers "stops" that other professionals have it place. A stop is an automatic sell order that kicks in when a price reaches a certain level. 

Large trading groups can see these stops clustered around specific points on charts based on technical analysis. They dump the paper shares with essentially an unlimited amount of force, it triggers the stops, then the prices cascade lower. 

Please understand this is not some government forced action. They short markets to make a profit and they do it extremely well. You can look at charts and see this occur. You probably notice that I have never advised "trading" here on this site. For an average person to think he or she can compete with a high frequency trader means they either do not understand how the markets work, or they are a compulsive gambler. You have a FAR better chance of winning money at a casino in Vegas than trying to "trade" the market. Anyone who tells you otherwise most likely trades for a living and would like to sell you their services (sound familiar?).

These traders just made a calculated move against gold and they made a tremendous amount of money. In addition to triggering stops in the market, many of the weak hands have panicked and sent prices even lower. Margin calls kick in when prices waterfall lower and that creates forced liquidation. These sellers only add more profits to the professionals. 

What comes next is the continuing accumulation of physical metals from enormous players in the market that will take advantage of the discount. I'm not talking about a hedge funds, I'm talking about the elephants like China and Russia. These countries have a clear understanding of how this story will ultimately end, and they step in during these panic declines and purchases enormous levels of physical metal. If prices go lower they will purchase much, much more. 

Over the years I have laid out a very clear argument of how I believe the story will ultimately end. If you are a longer term reader you should hopefully understand that all currencies around the world are fiat, paper money. Their worth is derived only through confidence in that paper. Confidence has the ability to evaporate overnight. I believe that one night it will. If you can put the larger picture into context and take short term emotion away then gold at $1,900 vs. $850 has very little relevance.

If you believed that gold was going to be $3,000 in 2016, would you rather have it be $1,300 or $1,900 in 2013? You would of course rather have the price be $1,300 so you could accumulate more metal today to sell at $3,000 in the future.

I remember seeing endless headlines about Apple, the media's new financial darling, just a few months ago. After crossing 700 it has collapsed down to 426 as of this morning. Is anyone talking about Apple today? No, they are focused on blue chip stocks that will lead a portfolio to the promise land. Why? Because blue chip stocks are the hot investment, the flavor of the week.

For an understanding of where we are today and how this story will ultimately play out I recommend reading the complete 2013 Outlook.