Precious Metals Consolidation on US 50 Basis Point Interest Rate Cut

By: Joe_Nicholson

“Now that gold has hit $900, the question becomes whether this magnetic price that played on the yellow metal for weeks, calling it ever upward, will act like $100 has for oil, or will gold break through.  Two factors that tend to indicate gold getting through that resistance level in a matter of weeks if not days, are the difference in the inflation adjusted highs for gold and oil, and the bullishness of the Fed's current rate cutting disposition. It's clear not only will the Fed cut by 50 basis points in January, it will justify … by a view of inflation that overlooks short term measures.” ~ Precious Points: Gold and Inflation , January 11, 2008

The theme discussed here last week intensified and even revealed it had spread to Europe, where an explicitly hawkish ECB was faced with declining Euribor rates and central banks in general are coerced by markets that are themselves only beginning to understand their potential for shaping monetary policy. The push for rate cuts from the ECB helped shore up the dollar against the Euro and contributed to weakness in metals this week.

Meanwhile, back home, just as it seems Bernanke can do no right, and even the President gets a muted response from the market, many are second guessing the Fed's every move, asking why, if they've already broadcast a rate cut for their next meeting, why don't they simply enact an inter-meeting cut? To some it's almost as if Bernanke is Marie-Antoinette saying “Let them eat cake”, or Nero fiddling while Rome burns. It's tough to say whether the Executive and the Fed actually believed the market would react enthusiastically to the Bernanke testimony/Bush-and-Paulson one-two punch, but yes, most likely they at least hoped so, despite the easy consensus it would not.

Officials would probably tell you they're waiting for more data before making a decision, but it's hard to believe the timing of the President's stimulus plan announcement was designed for any other reason than to take the wind from the opposition's political sails and to remove some of the pressure from the Fed, when it could have just as easily waited until the State of the Union address. Ironically, rate cut expectations jumped on Friday, despite the President's announcement making it all the less likely we'll get what the market would consider an “aggressive” rate cut in two weeks, though 50 bps is probably still the best guess. But of course now the insatiable market wants 75!

Amidst this backdrop gold ultimately saw a bit of a correction this week, though it was in fact a matter of days, not weeks, from the publishing of last week's update before gold climbed over $900 to unprecedented nominal highs as forecast. You can see from the chart below, gold burst through $900 early in the week, only to fall back below this level as economic worry was stoked worldwide and the dollar nonetheless stood its ground against major currencies with the help of tame inflation data that probably reflected more recessionary forces than true disinflation.

The chart above shows the first resistance level in gold at about $890, while the chart below shows support at about $861. The wide latitude is a testament to the rapidity with which gold has moved over the past five weeks and represents a range for traders. Long term investors should be getting close to satisfied with the move for now and accept a bit of a correction, if that is what is in the making here, as the mind-numbing crashes in commodities that plague the buy and hold investor always follow unsustainable parabolic ascent – undoubtedly what would be occurring if gold continued on the current trajectory upward.

Still, if judged by inflation-adjusted terms, gold and silver are well shy of record highs, even as oil flirts with its own inflation-adjusted record territory. One reason for the discrepancy was demonstrated this week: to get more oil on the market the president has to literally beg the Saudis, and even then he's lucky to get anything but a token response. Smartly, the Saudi's aware of inflation and make sure they are not suckered out of their profits by a sinking dollar. On the other hand, the U.S. and other western nations sit atop the largest stockpiles of precious metal and have actively dumped on the metals' markets to depress the price.

That understood, the current bull market is a product of the undeniable increase in demand, as well as the growing disinterest among governments to part with their metal reserves in an increasingly uncertain world. There's nothing to suggest this fundamental situation is going to change, meaning metals will continue to move slowly but inexorably towards their appropriate inflation adjusted highs, over $100 in the case of silver. And, contrary to popular belief, there's still utility for precious metals: in addition to the growing number of applications in industry and medicine, precious metals continue to be the greatest fungible, transportable, and liquid store of legal wealth in the world, and that will always create demand.

So, as mentioned here repeatedly, though metals are probably due to a bit of a correction here, the fate of the global and domestic economies, as well as the path of the Federal Reserve, will have the ultimate say. Metals traded largely in tandem with stocks last week, though their troughs were not as deep as the beginnings of true panic began to be felt. With additional rate cuts almost undoubtedly on the way, it's reasonable to see a more triangular correction in gold, if not new highs before the end of the quarter. That said, it's important to understand that even a larger degree triangle, as opposed to a deeper selloff, could still see gold trading to the $775-780 area in relatively short order. Those who've ridden this high should appropriately see themselves closer to the end of this move than the beginning.

But whatever comes in the next two weeks, another Fed disappointment would have uncertain impact for the metals, since the immediate impulse might be to sell, but too much panic might trigger some buying at lower levels. This said, the fate of silver might be the next big indicator for the future of precious metals. Expectations have been for silver to rally near the end of the move in gold. Well, as shown in the chart below, silver has moved above $16.50, and perhaps those expectations have been met.

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The most bearish scenario paints all the rally in silver off the summer '06 lows as the b wave up move of a three wave correction – a count that would have silver making new lows back to the single digits sometime this year. While that continues to be an extreme and low probability event, it's critical to find strong support anywhere in the $12 – $15 range to put aside fears of a deeper correction and keep the overall bull market alive. An advance from here is also possible, but that would tend to play into the deeper correction scenario as it could be interpreted as the end of the major leg up in gold.

So, going further into these “unusually uncertain” times, this is the best advice for those participating in the precious metals markets: some further upside is not entirely to be ruled out, but it's the nature of the next major consolidation and the location of ultimate support that will provide a solid understanding of the situation. And the higher and faster metals fly now from here, the harder they are likely to fall later.

by Joe Nicholson (oroborean)

www.tradingthecharts.com

This update is provided as general information and is not an investment recommendation. TTC accepts no liability whatsoever for any losses resulting from action taken based on the contents of its charts,, commentaries, or price data. Securities and commodities markets involve inherent risk and not all positions are suitable for each individual.  Check with your licensed financial advisor or broker prior to taking any action.

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