The Federal Reserve announced on Oct. 15 it will continue its policy of “printing money,” in the hopes of stimulating additional lending. What does this second round of quantitative easing (QE2) mean for the precious metals markets?

Probably not much.

Although retail investors might expect precious metals commodities like gold and silver to surge upward when the Fed floods the financial system with money, QE2 is unlikely to have a major impact on these markets. 

The markets took off to the upside shortly after the QE2 announcement last Friday, with silver leading the way. And, prior to that, investors had already priced in the real gains ahead of the announcement.

Going forward, the QE2 program is unlikely to spur new record highs in gold, silver and the like - instead, it will merely sustain the current favorable environment to the metals ... i.e., U.S. dollar devaluation, investor uncertainty and inflationary pressures.

As of Oct.20, gold futures were down at $1324.70, silver fell to$23.12 and platinum was down to $1,683. But the markets seem to expect these prices to rise through the end of the year.  

Rather than reading too much into the QE2 program, investors should instead pay closer attention to three other factors that could significantly impact the price of gold and silver:

CFTC Investigation Into Silver Manipulation: The Commodity Futures Trading Commission (CFTC) has been looking into possible “silver manipulation” for about two years now. 

Silver investors have alleged that a handful of U.S. banks have been controlling a high percentage of silver’s short positions. Data from the CFTC shows that just two U.S. banks controlled 25% of silver’s short positions.

Foreclosure Moratorium: If the banking system is prevented from proceeding with foreclosures for a long period of time, it could have many holders of this debt in overseas markets selling these bundled loan packages and driving the price down further. 

As these foreign investment firms become more disenchanted with the U.S. rating services and all that went into packaging these loans, their incentive to divest themselves of U.S. dollar investments increases.

Physical Short Squeeze:  We do not have clear evidence of this happening yet, but the chances of a physical short squeeze are increasing with time. Here’s why: As the price of gold and silver go up, there is a corresponding increase in retail investor demand for ETFs. As the number of ETF contracts increases, this will push hedge funds, institutions and sophisticated individual investors out of the ETF market - and into the physical metals. This investor migration could, if large enough, put a physical short squeeze on these small markets that are over-leveraged by naked shorts.

How high will prices go in the near-term? Longer term?

Of course, there is no way to predict, with an absolute degree of certainty, how high the physicals, futures and ETFs may rise in the next few weeks, as a result of such factors as QE2 speculation and the other ones noted above. However, it is possible to predict a movement range within the share prices that is likely to happen:

•Gold - In theory, a single troy ounce of gold should be worth about $2,500 per ounce to match the 1980 high on an inflation-adjusted basis. But, by the end of the year, it appears poised to near the $1,400 mark or possibly higher.  As all markets go up and down, the precious metals will experience some profit taking - and perhaps soon. For those investors holding gold as a long-term investment, there is no reason to fear. The price will stabilize after any correction and begin moving north again over the next several months.

•Silver - I strongly believe silver futures will reach, and then surpass, the record $25 mark this year. Silver has an 85-percent correlation with gold, meaning it moves with gold most of the time. Silver is a highly volatile market, though; so my advice is that a short-term investment here is a high-risk trade. However, silver can move and extend rapidly because, as outlined earlier, there are other factors to consider. The long-term trend for silver is quite good - even better than gold. In the next decade, I expect an ounce of silver to be valued at $100, due to the combination of investment and commercial demand, coupled with diminishing supply.

The precious metals markets are not well-suited for short-term investors hoping to make a quick buck.

Retail investors should look to these commodities as part of a long-term wealth management and protection strategy. 

I’ve always believed it is important to have significant holdings in physical metals like gold and silver, as a hedge against the decreasing value of currencies; but in these uncertain times, gold and silver have become more important than ever before for protecting wealth. But beware of "paper" gold, like some ETFs. Do your own objective study, because while some bullion holding investments are fine, others are simply price tracking devices. 

 

David Morgan is a widely recognized analyst in the precious metals industry and consults for hedge funds, high net worth investors, mining companies, depositories and bullion dealers. He is the publisher of The Morgan Report (www.silver-investor.com) on precious metals, author of “Get the Skinny On Silver Investing” (Morgan James Publishing, 2009), and featured speaker at investment conferences in North America, Europe and Asia.