Precious Metals Third-Quarter 2016 Review And The Outlook For Q4

Precious metal prices all added to 2016 gains in the third quarter. A composite of the active month futures prices of the four exchange-traded precious metals appreciated by an average of 6.17% in Q3. This composite dropped by 8.10% in 2014. The sector fell by 19.46% in 2015, but through the first nine months of 2016, precious metals have gained 26.96 %. The US dollar weakened by 0.85% during the last three months and is down 3.40% so far this year. A continuation of low interest rates around the world along with economic and political uncertainty has been supportive of precious metals prices in 2016.

Global interest rates continue to be at very low levels- in Europe, and Japan rates are negative and in China, they continue to fall and the currency, the yuan has been the subject of a devaluation program by the government. The U.S. Federal Reserve raised the Fed Funds rate for the first time in December 2015 and promised 3-4 additional hikes in 2016, but through the first nine months of the year, the central bank has not acted. Some statements during the quarter led market participants on wild goose chases as the Fed vacillated between hawkish and dovish messages at times. In late August several Fed officials told markets that an interest rate hike was "imminent." However, at the September FOMC meeting, the central bank left the short-term rate unchanged. Precious metals have become even more valuable during 2016 as low interest rates have provided support. The precious metal and base metal sectors continued to move higher from July through September.

Gold Review

Gold closed on December 31 at $1060.20 per ounce. It never traded to that level in 2016 as the price of the yellow metal moved higher on the first trading day of the year and never looked back. Gold fell 10.46% in 2015 - it was down marginally by 0.27% in Q3, but the yellow metal has gained 24.23% so far in 2016. Gold settled on September 30, 2016, at $1317.10 per ounce basis the active month COMEX December futures contract. Gold traded in a range between $1061 and $1384.40 so far this year with the highs coming on July 5, at the beginning of the third quarter and just after the surprise Brexit vote. The lows for the year came on the first trading day in 2016. Gold has made higher highs and higher lows throughout 2016. Physical demand for gold continues to be active around the world. Central banks have been net purchasers of the yellow metal with most buying coming from Russia and China, who have been adding to national reserves. While these monetary authorities bought around 550 tons in 2015, official sector purchases this year are likely to be closer to the 400-ton level.

Gold has appreciated in all currencies in 2016, which is a statement on central bank policy and gold. Gold is the oldest means of exchange in the world; it has been around a lot longer than any paper currencies in circulation today. Faith in government fiscal policy and central bank monetary policy is driving investment capital to gold which is becoming the ultimate safe-haven in severe economic and political conditions around the world. Gold producing equities have also attracted capital, but in Q3 mixed results were seen in the mining shares. The GDX fell by 4.62% over the past three months while the GDXJ appreciated by 3.97%. Open interest in COMEX gold futures contracts declined by 55,538 contracts to 565,759 contracts on September 29 - a decrease of 8.9%. As gold fell from the early July highs, many longs took profits on positions. Gold entered a secular bull market in 2016 and the pause in the upward trajectory in Q3 has not put the rising long-term trend in jeopardy.

The world continues to be a dangerous place and a flight to quality could continue to support gold at times during the year. Gold has appreciated in all currencies, and it is strong when compared with other precious metals and all commodity prices for that matter. Over the first nine months of 2016, commodity prices rose by over 10.50% on average, and the dollar declined by just over 3.4%, and gold has outperformed many assets rallying by over 24%. Only high-quality government bonds and the Japanese yen gave gold a run for its money as capital seeks safe havens. After bear market action for over four years, there has been a critical change in the gold market in 2016.

In Q4, the most controversial Clinton versus Donald Trump contest is an election like we have never seen in the United States. The only thing that the two candidates have in common is that many voters in the U.S. detest both, and they each have some of the lowest approval ratings in history. The election is five weeks away and is likely to cause volatility in markets across all asset classes in the U.S. and around the world.

Silver

Silver is the best performing precious metal in 2016 at the end of the third quarter. Silver gained 3.17% in Q3 and is up 39.20% over the first nine months of this year after moving 11.51% lower in 2015. In 2014, silver shed 22.82% of its value. Silver settled on September 30 at $19.2140 on the active month COMEX December futures contract. Silver has traded in a range between $13.75 and $21.25 throughout the year so far. Silver usually displays a higher degree of volatility than gold, and it tends to attract more speculative activity. As of the end of Q3, daily historical volatility in silver was 22.94% while daily historical volatility in gold was 10.05%. Over recent weeks, silver has been leading gold lower and higher. Meanwhile, open interest in silver futures traded on COMEX moved from 208,522 contracts at the end of Q2 to 200,854 contracts on September 29, 2016 - a decrease of 3.7%. Open interest in silver was at all-time highs at the end of the second quarter of 2016 and has declined slightly since.

Silver is an industrial precious metal and concerns about the health of the global economy were a roadblock for significant early in 2016. Silver has a dual role as a precious metal or hard asset and an industrial metal. The current economic and political landscape has transformed silver back into its historical role as a hard asset and safe-haven when compared to fiat currencies. As we move into Q4, I will continue to watch the silver-gold ratio, which closed the most recent quarter at 68.55, the ratio moved lower over the quarter by 2.36 a sign a rebound and transformation of silver to a hard asset. The ratio traded to highs of over 83:1 in early March of 2016 which was the highest level in 21 years since 1995. Silver continues to underperform gold on a historical basis as the long-term pivot point for the ratio is around the 55:1 level.

Outlook for Silver in Q4

Like gold, the long-term chart for silver has improved given price action during Q1.

The monthly chart for COMEX silver futures shows that the slow stochastic, a momentum indicator had crossed and shifted higher in oversold territory in Q1, and the trajectory of the move higher gained steam. Higher highs is a positive sign for the metal and resistance for silver is now at the recent July highs of $21.25 per ounce, above that level, the July 2014 highs of $21.5250 comes into play. Support is at $17.45, the 50% retracement level of the move from the late 2015 lows to recent highs. In another bullish technical sign for silver, the precious metal put in a bullish key-reversal trading pattern on the long-term monthly chart in June and has been consolidating at a higher level since.

The long-term (40+ year) median for the silver-gold ratio is around 55:1. The divergence in the ratio continues to tell us that silver is too cheap at current levels, or gold is too expensive. The Q3 ending price of gold would imply a silver price of $23.95 per ounce if the relationship were to return to its historical mean. That price is $4.736 per ounce above the current market price. Conversely, silver at $19.2140 would imply a gold price of $1056.77. Eventually, something has to give in these precious metals. While the ratio is only a benchmark for value, prices have tended to return to the mean over the past four decades.

As the monthly chart of the ratio illustrates, it has a penchant to revert to the average. The trend in the ratio has shifted lower, and the target is now around 63:1. We need to keep our eyes on this value- relationship for clues about the trajectory of silver in the months ahead.

Silver fundamentals are difficult to evaluate as a significant percentage of silver comes as a by-product of copper, lead, zinc and tin concentrate output. Silver tends to attract speculative interest because of its volatility; therefore it could provide clues in coming months as to the price path of all commodities on a macro basis. As in gold, I believe we saw important changes in the silver market during the first six months of 2016, and I favor buying dips to initiate positions rather than selling rallies. I prefer trading the precious metal as opposed to investing in it, taking profits on price rallies and using price drops to reload on the long side. 2016 is a year where trading rather than investing is the way to achieve optimal results.

Platinum

Industrial precious metal prices had been suffering under a weak global economic landscape for the past few years. January platinum futures closed on September 30 at $1034.50 per ounce. Platinum lost 26.24% of its value in 2015 after being down 14.35% in 2014. In the third quarter of 2016 "rich man's gold" gained 1% and is up 16.01% so far in 2016. Platinum traded in a range between $812.40 and $1200.40 during the first nine months of the year.

Platinum is a rare precious metal that is expensive and difficult to mine. The vast majority of platinum production, eighty percent, comes from South Africa. As an industrial precious metal, a large percentage of platinum demand comes from its use in automobile catalytic converters. Slower growth in China and Europe continues to weigh on the platinum market; industrial demand was weak for the rare precious metal. Currency volatility in the South African rand likely contributed to platinum's weakness. Weak auto sales around the world have also weighed on platinum as have technological advances reduce automotive demand for the precious metal.

Investment demand has not been buoyant in platinum, and it has remained weak compared with gold. Platinum, like many other industrial commodities, posted a new multi-year low in early 2016 before the price corrected. However, platinum is also a precious metal with a history of investor interest. It may only be a matter of time until the price appreciation in gold and silver causes a fast and furious rebound in the price of platinum. Some speculative or investor interest may be returning to the platinum market. Open interest in NYMEX platinum futures increased to all-time highs of over 81,800 contracts in August before coming lower to close Q3 at the 68,847 contract level, 7,601 contracts or over 12.4% higher at the end of Q3 compared to the end of June 2016.

The platinum-gold spread closed 2015 at a $168.50 discount; platinum was cheaper than gold. The long-term median level for this relationship over the past four decades has been around a $200 premium for platinum over the price of gold. The premium reflects the rarity of platinum; there is more than ten times the amount of gold produced each year than platinum, and on a per ounce basis, industrial applications for platinum are much more than for gold. During Q2, the discount increased to just over $350 - a new, modern day, all-time low. On September 30, this relationship closed at $282.60 platinum's discount under gold decreased by $10.90 from the end of Q2. However, during Q3 there was some wild volatility in the spread as it traded all the way down to just below a $170 discount (platinum under gold) on August 10 when platinum rose to highs of around $1200 per ounce.

As the quarterly chart of the price of gold minus the price of platinum reveals, before 2015 platinum had never traded to a discount of over $200 to the price of gold. In 2008, it sold at over a $1200 premium. The nickname for platinum is "rich man's gold" - in recent years it has been anything but that, platinum has not traded at a premium to gold since 2014.

The daily chart of the price relationship highlights the volatility in the spread during Q3.

The discount tells us that platinum is either too cheap at its current price or gold is too expensive on a relative basis. The September 30 price of platinum implies a price of $834.50 for gold given a reversion to the mean on the long-term price relationship. On the other hand, it also could suggest a platinum price of $1517.10. The divergence is significant and based on the closing level of $282.60 per ounce platinum would need to rally by $482.60 or 46.7% to revert to the long-term median level for the price relationship. Divergence often creates the most profitable trading opportunities

.

Outlook for Platinum in Q4

Platinum is rarer than gold. While gold production amounts to approximately 2,800 tons per year, there is only about 250 tons of platinum output each year. Moreover, due to its properties, industrial applications for platinum are numerous. Platinum is also far less liquid than gold. Therefore, I believe that over the long haul, platinum will eventually outperform gold once again. For the long-term; purchasing physical platinum may be a better option than buying physical gold or silver in the precious metal markets today. Premiums on platinum coins and small bars are high which indicates a shortage of these products available to the general market. I favor buying NYMEX platinum contracts and standing for delivery as opposed to buying retail platinum bars or coins at very high premiums in this market. Each NYMEX contract contains 50 ounces of the metal, which means that at a price of $1034.50 per ounce it costs $51,725 to purchase a platinum contract. There are some additional fees for taking delivery and removing the metal from warehouse receipt, but those costs are far below the premiums today for coins and small bars making the NYMEX route to physical far more attractive for physical purchases. At the end of Q2 I wrote,"I believe that this precious metal is preparing to surprise on the upside, and the liquidity of the metal will make the rally spectacular. The downside is limited and upside explosive in platinum when it finally decides to be an investment vehicle and safe-haven investment once again." Platinum rallied to $1200 per ounce in August before it retreated to its current price. I remain bullish on platinum. Support is at $1000 per ounce, but I view $950 as the critical level given the potential for volatility in the precious metal.

Palladium

Palladium was the best performing precious metal in Q3 as it gained 20.78% and closed on September 30 at $721.50 per ounce. Palladium has rallied by 28.38% in 2016. Palladium fell 29.61% in 2015 making it the worst performing precious metal of last year. Palladium traded in a range between $451.50 and $747 during 2016 so far. The lows came in early January, and palladium has recovered since then with the most recent highs coming on August 10.

Palladium, a platinum group metal, is a rare precious metal. Russia, more precisely the Norilsk Nickel mines in Siberia, produces the majority of the world's palladium. The fact the selling pressure may be off nickel which was up over 13% in Q2, could mean that Russian selling in both nickel and palladium has slowed, or demand has increased. The all-time high for palladium in January 2001 was at $1090 per ounce. As with platinum, a large percentage of palladium demand comes from its use in automobile catalytic converters and the weak global economy weighs on demand for palladium.

Outlook for Palladium in Q4

Palladium has been a star in Q3, but the price is now at a level where caution is appropriate. Open interest in NYMEX palladium futures rose from 21,806 contracts at the end of Q2 to 27,406 contracts on September 29 -- an increase of 25.7% over the three-month period. Increasing open interest provides technical validation for a rally, so the trend in the palladium market is strong. While the technical picture for palladium continues to support more gains, we will need to see more upside action in platinum, silver, and gold for palladium to continue its march higher.

The bottom line

Precious metals have held gains made earlier in the year during the third quarter of the year.

Interest rates in the U.S. and around the world remain close to historical lows. Low rates are a supportive factor for gold, silver, platinum, and palladium. The dollar is in the middle of its trading range awaiting the results of U.S. election in five weeks.

The surprise referendum results in the U.K. in June caused the value of the British pound to fall from $1.50 to $1.30 almost overnight. Any surprises in the U.S. election could cause some wild volatility in the U.S. currency which would like translate to moves in precious metals, especially gold and silver. Additionally, the Fed meeting at the end of December will once again raise speculation whether the central bank will hike rates at least one in 2016.