Have precious metals bottomed?

After a gut wrenching correction that drove gold and silver prices down 38% and 63% respectively from their 2011 highs, the recent price action in precious metals has been dramatic. From the low on June 28th, gold bullion has appreciated by more than 11%, but the real fireworks have been seen in gold mining equities with the NYSE Arca Gold Bugs Index up close to 20% and the junior miners, as measured by the Market Vectors Junior Gold Miner ETF, up a stunning 33%! Silver has joined the party, increasing by 17% over the same time period and silver stocks as measured by the MSCI Silver Index are up 28% to August 16. This price action confirms that the sentiment for precious metals and miners has changed dramatically, and it couldn’t have happened soon enough.

The bottoming process in precious metals investments has been an extended and frustrating affair. Investor sentiment appeared to be hitting rock bottom at the end of June after the metals and miners were pummeled with a series of negative developments. Federal Reserve Board Chairman Ben Bernanke started the downward plunge in gold at his post-FOMC press conference on June 19 when he suggested the Fed would begin to moderate the monthly pace of bond purchases. Gold was pushed down to $1,255 in short-order and subsequently drifted to a low of $1180 by June 28th. Adding further insult to injury, India has continued to wage a war on gold imports in a desperate attempt to control capital flows out of the country. India, which is the largest gold consuming country in the world, has repeatedly increased import taxes and added import restrictions on the purchase of gold bullion. Meanwhile, as revealed yesterday through SEC filings, one of the largest and most followed gold investors in the world, John Paulson sold over half of his position in the GLD gold ETF during Q2. These are his first sales since 2011 and came “due to a reduced need for hedging”. Also reporting sales of bullion were other high-profile hedge fund managers, including George Soros and Daniel Loeb, who completely liquidated their gold positions during the second quarter.

According to the World Gold Council, overall demand for gold dropped 12%to 856.3 tons in Q2, led by the 400 tons of ETF selling. Sentiment was further eroded by the poor financial performance of gold miners who, as a group, have announced more than $21 billion of write-downs in the past two months after the metal’s steepest quarterly drop in decades.1 In aggregate, this barrage of negative data pushed precious metals and equities into an oversold condition.

Despite waning investment demand in recent months, gold has been supported by exceptional physical demand coming largely from Asia. The World Gold Council reported that consumers purchased 1,083.2 tons of gold in Q2, a jump of 53%year-over-year. Gold bar and coin purchases jumped to a record while jewelry demand reached its highest level since 2008 as bargain hunters took advantage of the falling prices.

As we enter the strong seasonal period for gold demand, investor sentiment has improved with those holding short positions forced to cover in the face of recovering prices. Among the gold miners, massive write downs, the cancellation of expansion plans and expense claw backs are positioning the sector for stronger results as gold prices recover. With precious metals equities rallying more than 20% in recent days, it appears that the tide has finally turned.


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