You probably know that silver prices usually track and follow gold prices but often amplify them during declines. Silver is both a precious metal used as a value reserve, but it’s also an industrial metal well known for its physical qualities, and used in numerous technical applications. Those two features make silver very attractive not only for industrial players but also for financial investors.

Silver prices are therefore driven by real factors like mining extractions or industrial demand, but also by speculation and other financial factors. Some of them become more significant over the time, depending on the economic and financial context. It appears that the leading factor recently has been the financial deleveraging. Indeed, the massive liquidations of positions from hedge funds which chase cash to face redemptions and therefore reduce drastically their risk exposure have been the key factor of the recent sell-off.

After oil and gold, silver is the third most accessible commodity in the world thanks to numerous financial contracts, futures, ETF’s, options, certificates etc…

The price action posted a low recently in parallel with the low posted by gold prices, in late October. Silver prices touched a low at $US 8.40, and have now bounced back at $US 10.35. It may confirm that the bearish trend started in March 2008 (point A on the chart) is likely to have ended last month (point B). This bearish trend has generated a loss in value of roughly 60% in silver prices.

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The chart shows the strong positive correlation between gold (red line) and silver prices (black bars). Since the beginning of 2008, this correlation was almost perfect. However, since mid-August, silver prices have been failing to keep up the pace and are much more “heavy” than gold prices. As mentioned in our last update, silver prices have been manipulated in July and August as 2 US banks accumulated massive short positions that created a panic movement on the downside. Now that the sell-off may be over on the near-term, a further rebound is probable. The technical momentum and MACD indicators signal that some positive trend is building up. In this scenario, the retracement levels of the bear trend occurred this year (between points A and B) may act as targets and resistance levels for the current price action.

The first resistance might be the 23.6% Fibonacci ratio at $US 11.50. However the main target will be the 38.2% ratio (around $US 13.50), which is a more significant level in technical analysis. Furthermore it’s a previous high that the price action already failed to clear in last September.

Real estate and equity prices have crashed and it’s almost impossible to know when they’re going to recover. Fixed-income investments are growing riskier by the day due to the global credit crisis and the projected spike in bankruptcy rates.

But here’s the reality: The U.S. government is printing money so fast, that cash is not even a safe bet anymore. That makes gold the safe bet in these rather stormy economic times.

Investors who purchased gold lately have been disappointed because the price of gold has not responded to the crisis as expected. Just think about it: If we had told you a year ago that this financial crisis was going to be so severe, would you have bet on gold falling by 30%?

Anatomy of a Disappointment

My guess is that very few of you would answer “no.” We have spoken with many confused investors lately, who don’t understand why gold is not responding positively to the current crisis. As you can imagine, this only adds to their confusion of the global markets.

Once again, it’s important to understand what moves the price of an asset short-term and what is driving that same price in the long-term. The long-term outlook for gold is still very attractive. We simply don’t have a growing supply to match the rising demand for gold.

The massive infusion of liquidity is ultimately going to lead to a massive spike in capital flows, and an upward pressure on inflation. This should also support the price of gold longer-term. Also, the weakening U.S. dollar in recent years drove gold prices higher. And the current temporary dollar recovery is also having a negative impact on the gold price.

However, at the moment, the short-term impact of various factors is out-weighting the positive long-term fundamentals.

Behind the Scenes in the Gold Markets

The reason gold has not performed well in the last couple of months is because institutional investors are dumping their gold holdings. These institutional investors need liquidity fast, so they’re selling gold. This actually shows how bad the current crisis is for many. Gold is now one of very few assets that can be easily liquidated to generate cash.

And the creativity of the financial industry has resulted in the development of a lot of commodity-linked investment funds. Typically funds buy gold as one of the hard and soft assets in their commodity-backed baskets.

These funds have all been facing a massive amount of redemptions lately. That means fund managers are forced to sell all commodity baskets they own…including their positions in gold. They could not differentiate between oil, agricultural commodities, metals and precious metals due to the nature of these investment baskets. This just adds more selling pressure on gold.

The temporary recovery of the U.S. Dollar has also kept prices rather low, but the U.S. Dollar recovery is driven by short-term money flows. We at Alpine find it hard to believe that the U.S. Dollar will continue to gain ground.

While we have seen the price of gold falling, a physical shortage of gold has developed. Go to any bank here in Switzerland and tell them you would like to buy a large amount of physical gold, either as gold bars or coins. Most of them will tell you that you have to wait a couple of days or even weeks because they are running out of inventory.

This is because more investors are distinguishing between “paper gold” exposure like investment funds and physical gold that they can touch and store in a vault. The problem is that many investment products are directly linked to the credit risk of the product issuer. This was not a big concern a year ago, but it certainly matters today - as we’ve seen so many troubled banks collapse under the credit crisis.

So if you plan to invest in gold certificates or funds, be sure your investment is physically backed by gold. Also check to ensure your investment is easily tradable, and backed by a counterparty with low credit risk.

These are uncertain times and could remain so for quite some time to come. Eventually, we believe that the market is going to focus more on the longer-term outlook for gold again and the short-term selling pressure is going to subside. This should drive the price of gold upwards towards US$1,000/ounce, possibly even higher.

We predict that ultimately, gold will shine again and that time could come sooner rather than later.

Gold is bouncing back. According to the World Gold Council, which has released its last statistics recently, the demand has surged on the third quarter: from the jewellery industry first, but also from investors through certificates and ETF’s.

The physical demand has surged in Europe and in the US, but despite those flows prices remained between $700 and $800 an ounce on the market during the last month. After several months of correction and sharp countertrends, the last 4/5 weeks have been a consolidation phase.

Despite the turmoil on the finance sector and the banking crisis, the equity markets’ plunge and the growing global recession, gold prices did not soar as it could have been expected. Indeed, the deleveraging of the hedge funds that have been facing large redemptions has capped prices on the upside.

Last but not least, the US Dollar strengthening and the lower concerns about inflation (as commodity prices all fell sharply) have weighed on Gold prices.

Technically, the price action found some support just below $700 (point D on the chart), which is a previous low level tested several times in 2007 (points A, B and C). The main support level, around $635, has not been tested. This level is a previous high posted in late 2005 and that became a new low several times in 2006. On the downside, gold prices are therefore well supported by those two levels ($700 and $635).

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This morning Gold is trading around $820, which is more than 16% higher than 12 days ago. A further rebound is expected. On the upside, the main resistance is the line that goes through the lower highs posted since the historical peak of March 2008 (points E, F and G). The target for the price action is consequently just below $900.

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On the short-term chart, the indicators argue indeed for a further rebound. First, the Bollinger Bands are bullish as sharp price changes tend to occur after the bands tighten, as volatility lessens, which is the case here (the bands therefore volatility tightened in November during the consolidation phase). Second, when prices move outside the bands, a continuation of the trend is implied. This is also the case here.

The MACD has also triggered a positive signal two weeks ago, and its rise shows that some bullish momentum is building up.

In this scenario, the level of $890 may be the target and the first significant resistance on the medium-term.

Gold finished below $US 800, finishing the biggest weekly slide for the metal in a quarter of a century as punters, speculators and anyone else just went off the metal big time. The surging greenback helped, but there seems to have developed a real disinterest in the metal, despite the continuing instability in Georgia and Russia’s bellicose stance. Seeing gold peaked at $US1033.90 on March 27, it’s now at $US792.10, down more than $US240 an ounce, or more than 23%. Comex December gold fell $US22.40, or 2.8%, to $US792.10 an ounce on Friday in New York. The metal fell 8.4% last week, the biggest drop for a front contract since February, 1983. Gold has fallen every day this month except for a 2.1% gain on August 13. December silver futures fell $US1.43, or 10%, to $US12.93 an ounce on Comex, the biggest fall for a most-active contract since June 13, 2006. Prices are still; up on a year ago, but the gap is shrinking. That gold prices peaked a good four months before oil did means investors lost faith in gold before the final surge in inflation off the back of the roaring price of oil. World prices retraced back to well over $US900 an ounce as inflation surged in May- July off the back of higher oil and petrol prices and the continuing impact of high food prices. But it never followed oil back into record territory. Falling demand from users, such as jewellers looks to have been more important than speculative interest: an oversupply of the metal started depressing prices. That’s an old fashioned concept, supply exceeding demand in these days of hedge funds and other ‘financial’ investors. That’s the view of the World Gold Council in its second quarter wrap up, released last week. Here’s what it reported: “The high and volatile gold price continued to dampen demand in tonnage terms during Q2, particularly for jewellery. While the average gold price, at $896.29/oz based on the London pm fix, was well below the peak of $1,011/oz seen in mid-March, it nevertheless represented a 34% rise on the average price of Q2 2007. Total identifiable demand fell 19% relative to year earlier levels to 735.6 tonnes. In contrast, total demand in value terms rose 9% on year-earlier levels to reach US$21.2bn – a new all-time quarterly record. In volume terms, jewellery was the biggest contributor to the overall annual decline, falling by 158.7 tonnes (24%) to 504.0 tonnes. However, despite the adverse economic conditions affecting much of the globe, consumers continued to increase their spending on gold jewellery. In value terms, demand rose 2% from year-earlier levels to $14.5bn, a new quarterly record. Identifiable investment demand was also softer than year-earlier levels as some investors took profits, but was nevertheless more resilient to the high gold price than jewellery demand. The 4% decline in tonnage relative to year-earlier levels represented a 9% decline in net retail investment; partly offset by a change from small net disinvestment to small net investment in Exchange Traded Funds (ETFs) and similar products. Inferred investment demand (which cannot be directly measured and is proxied by the statistical residual) continued to enjoy sizeable inflows. During July, total gold held in gold Exchange Traded Funds exceeded 1,000 tonnes for the first time.

Second quarter industrial and dental demand declined by 5% to 111.8 tonnes, primarily due to declining demand for gold in the dental and ‘other industrial’ sectors, in response to the continued high gold price. In value terms, this was equivalent to $3.2bn, a rise of 27%.

Gold supply grew by 1% in tonnage terms relative to year-earlier levels. A 13% increase in scrap due to the higher gold price was offset by a 4% reduction in mine output. Supply was also restricted by lower central bank sales.

India was the biggest contributor to the fall in gold demand during Q2, as it was in the first quarter. Both jewellery and investment demand were severely affected by the high and volatile gold price and higher local inflation, which has squeezed disposable incomes.

Jewellery demand in Q2 was down 47% in tonnage terms on the levels of a year earlier, while net retail investment fell 41%. Indian demand also fell in US$ value terms, by 29% in jewellery and 20% in investment.

Other major gold consuming nations experienced a more mixed quarter. On the jewellery side, only China and Egypt experienced a rise relative to year earlier levels in tonnage terms.

In China’s case, the rise was just 2% while in Egypt the rise was somewhat larger at 8%.

High levels of the gold price, and high volatility, have been a key deterrent along with rising petrol and food prices, which have squeezed disposable incomes. 

Countries and regions that suffered the largest decline in percentage terms (apart from India) included the US (-30%), Taiwan (-20%) and the UK (-20%), and the “Other Gulf” region (-23%), which was largely attributable to a decline in Kuwait.

Nevertheless, the fact that the dollar spend on jewellery in most countries remains above last year’s levels is encouraging given the current economic environment.

Countries that enjoyed strong growth in net retail investment inflows included China, the US and Vietnam.

Higher inflation and falling stock markets were a common theme in all three countries, highlighting the inflation hedging and safe haven motives for investing in gold.

Net investment demand in Vietnam in H1 2008 totalled 56.8 tonnes, already just outstripping the 56.1 tonnes recorded for the whole of 2007. In Q2 2008, demand more than doubled in China from 4.3 to 9.8 tonnes, and in the US, rose from 1.2 tonnes to 11.3 tonnes.

In Japan, sales of existing gold holdings by investors seeking a profit outweighed purchases to the tune of 12.1 tonnes.

This level of net selling back was well below the record 39.3 tonnes seen in the previous quarter, reflecting the move in the gold price down from its earlier highs.

September crude oil fell $US1.24, or 1.1% in new York Friday to finish at $113.77 a barrel. That left it off 1.2% in the week.

Figures from the American Petroleum Institute show that demand for petrol fell 2.1% in the seven months to the end of July. Petrol prices at the retail level in the US continued to fall at the weekend, closing at $US3.77 a US gallon, well down on the all time high of $US4.11 reached on July 17.

Jiangxi Copper, China’s second-biggest smelter of the metal, said last week it would cut output of copper rods and wires by 30%. This is on top of other cuts by other Chinese producers in recent weeks.

Comex copper December delivery rose 1.65 US cents a pound in New York on Friday, to $US3.3145 a pound.

The price fell 0.4% over the week.