Gold And Silver Prices Drop—Why?

As has often happened early in a new calendar year of late, gold and silver prices have declined. Gold and silver have really been seriously clobbered since late in the afternoon on January 13.

Price drops of this magnitude don’t just happen by accident. There are one or more reasons to explain them. However, the excuses offered by the mainstream media don’t even come close to making sense.

One huge reason why prices dropped from the 13th to 14th is based on fact. Another huge reason is plausible though not derived from admitted fact.

On Thursday, January 13, Moody’s Investor Services issued a report stating that the current fiscal situation in the US is such that, if not reversed, it will result in a lower credit rating for US government debt. Sarah Carlson, senior analyst at Moody’s, said, “We have become increasingly clear about the fact that if there are not offsetting measures to reverse the deterioration in negative fundamentals in the US, the likelihood of a negative outlook over the next two years will increase.”

The same day Carol Sirou, who heads Standard & Poors in France, said in a speech, “The view of markets is that the US will continue to benefit from the exorbitant privilege linked to the US dollar” to fund deficits. “But that may change. We can’t rule out changing the outlook” on US government debt. She later said, “No triple-A rating is forever.”

These twin announcements had the expected effect on the value of the US dollar, which dropped in value against other currencies about 1% Thursday afternoon.

Normally, when a currency declines like that, alternative safe haven assets rise in price. Gold and silver would typically experience higher demand and higher prices. However, rising precious metals prices would reinforce the decline of the US dollar. Therefore, the US government had a huge incentive to prevent gold and silver prices from rising.

That appears to be almost exactly what happened. Usually, when gold and silver prices are falling, the number of open contracts on the COMEX declines as traders sell off their long positions. Short buyers who purchase such contracts then close out their position.

In the past 48 hours, there has been a significant increase in the open interest, which is a sign that one or more parties, probably trading partners of the US government such as JPMorgan Chase and HSBC, have sold as many short contracts as it took to push down the prices of both metals. This has been a standard price manipulation tactic for several years, so I have little doubt it has been done again.

The plausible reason for the decline in gold and silver prices over the past 10 days is that the sharp increase in gold and silver prices at the end of 2010, especially late in December, is that there was a supply squeeze in COMEX inventories. Of total COMEX silver inventories, about 50 million ounces is currently registered, meaning that it is automatically available to cover delivery commitments of maturing contracts. That amount could be absorbed by fulfilling only 10,000 contracts. As I write this, there are 78,000 short contracts owed for March 2011 maturity.

There are extensive rumors flying that an unusually large number of December 2010 contracts were held for delivery of silver, which was not physically possible. Instead, many of them were supposedly settled for cash, often at a premium to “spot” price. This certainly would explain why the price of silver rose almost 50% in the last three months of 2010.

Apparently this tactic was so profitable for hedge funds and other deep-pockets investors that they are gearing up to repeat the process with the March 2011 silver contract on a much larger scale. At current prices, $1.5 billion could purchase the 10,000 contracts needed to deplete the entire stockpile of COMEX registered silver. The rumors are that these buyers are looking to jump in to make purchases during February and eventually force the price of silver up to about $45 before the end of March. Obviously, there are many hedge funds, private investors, and sovereign wealth funds that could raise enough cash to handle this raid on the COMEX silver market all alone.

However, you can be sure that the traders for banks that hold huge short positions (widely understood to be JPMorgan Chase and HSBC) are hearing of these plans. One defensive tactic to hold off the onslaught would be to dump a lot of paper contracts on the gold and silver markets to force down prices before the buyers start making their purchases in February. Then, when prices have fallen significantly, the short sellers could purchase lots of contracts and physical metal to help them fight back against the supply squeeze effort and also to discourage a planned raid on the COMEX inventories. Hence, you could expect a significant drop in gold and silver prices—right about now!

It doesn’t matter whether the second of these reasons is completely true or not, it is factual that the value of the US dollar is dropping. That should result in much higher gold and silver prices in the near future. I regard the current drop in precious metals prices as simply one more temporary buying opportunity.

Patrick A. Heller owns Liberty Coin Service in Lansing, Michigan and writes “Liberty’s Outlook,” a monthly newsletter covering rare coins and precious metals. Past issues can be found online at http://www.libertycoinservice.com/ Pat Heller is also the gold market commentator for Numismatic News. Past columns online at http://numismaster.com/ under “News & Articles”. His bimonthly columns on collectibles can also be read at http://www.lansingbusinessmonthly.com under “Articles” and “Department Columns.”His radio show “Things You ‘Know’ That Just Aren’t So, And Important News You Need To Know” can be heard at 8:45 AM Wednesday mornings on 1320-AM WILS in Lansing (which streams live and becomes part of the audio and text archives posted at http://www.1320wils.com.