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Outlook for Precious Metals in 2011: Will the Rally Sustain?

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Although the dollar can rally alone, if non-USD demand remains strong, precious metals prices could hold or even increase.

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For the full version of this essay and more, visit Sunshine Profits' website.

Gold has gained 26% this year, putting it on track for its third double-digit gain of the last four years. To chart gold's price movements since 2000 take a piece of paper and draw an outline of an imaginary mountain slope (think Everest) with a few footholds to rest on the steep way up. There's still a long way up before you can plant the flag at the top.

Eurozone concerns dominated the gold trade in the first half of the year. For the astonishing second half, dollar weakness was the major story with the yellow metal reaching more than a dozen record highs. It got a boost in late August after Federal Reserve Chairman Ben Bernanke proposed expanding the Fed's bond-buying efforts with a second round of quantitative easing. For the most part, only modest retracements punctuated the winning streaks.

Let's take a look at the fundamentals that have been driving the prices of precious metals higher this past year as well as some of the pitfalls that may lie ahead. All the factors that have driven gold higher -- fear, uncertainties, the Fed's printing press, lack of confidence in the dollar, gold as the ultimate currency, buying by newly wealthy Chinese families, sovereign troubles in the eurozone, central bank purchases, high unemployment in the US -- are still in place and I don't see any of those factors changing significantly in the coming year.

Several analysts and gold pundits support a continuing bullish time for gold in 2011. Several forecasts predict gold has $100 to $400 more to gain this coming year. The timing of the peak may depend on interest rates. Analysts at Goldman Sachs say gold prices are likely to continue their upward trajectory next year, but will likely peak on rising interest rates at $1,750 an ounce in 2012. Peter Schiff is on the record as predicting that gold will go up to $2,000. Jim Rogers said in an interview recently that gold is going to go a lot higher over the next decade. If adjusted for inflation, it should be over $2000.

There have also been predictions about gold's "crazy little brother," silver, the leading performer in the metals this year. Will it repeat its success in 2011? Standard Bank Plc said it sees silver at over $40/ounce due to new applications and increased industrial demand.

As far as I'm concerned, I would guesstimate gold's high for 2011 at $1,800 and $45 silver. My very-long-term charts suggest even higher targets for the following rallies, but because it's 2011 that we're talking about in this guesstimate, I'll stick with the abovementioned levels.

So what are the pitfalls for precious metals? The first is that the economy will heal (which may not be a bearish factor at all in case of silver because of the number of its industrial applications), the Fed will stop printing money, the euro will stabilize, and the Chinese will stop buying gold. The chances of that happening are nil. Instead what I see in my crystal ball is bankruptcies looming at the state, county, and municipal level throughout the US.

The US Federal Reserve is forced to buy T-bills from the Treasury department just so the government can continue to stay operational. Or, what is even more likely, that the bankruptcies will be prevented by printing more money, thus fueling inflation and precious metals' rally.

A more realistic drag on gold could be the possibility of surging interest rates in Europe and the US. Higher interest rates would push investors away from gold, which bears no interest, pays no dividends, and thus carries an opportunity cost. However, higher long-term yields reflect rising inflation expectations and diminishing confidence in the US dollar, and those are bullish for gold.

Speaking of the economy, let's take a look at the indications coming from Euro and USD Indices. Let's begin with the Euro Index chart:


Source:StockCharts.com

On the above chart we clearly see that the resistance levels continue to be retested. Note that a previous support level is now providing resistance and has held for a second time. At this point, further declines could very well continue here and this would likely lead to a corresponding rally in the USD Index.

The head-and-shoulders pattern, which appeared to be under development in recent weeks, may not be completed given the abovementioned action or it may not be completed in a classic manner, meaning that price would simply trade sideways below the rising resistance line, retesting it over and over again after finally declining. Either way, further consolidation is possible but it seems more likely that declines will be seen with an eventual break below the 200-day moving average support level.

Again, since the euro is the biggest factor determining the USD Index, what's bearish for Euro is bullish for the USD Index.


Source:StockCharts.com

The very long-term USD Index chart, which spans nearly 20 years, allows us to truly put 2010 in perspective. When viewing a short-term chart, the USD Index appears to have rallied to a much greater extent than is seen when compared to prior years. Simply put, the very long-term declining resistance line has not been surpassed in the past 12 months and is still likely to provide strong resistance once it is approached.

What this means is that any rally ahead in the USD Index may not surpass the 83 level, which is where this resistance line currently resides. This is a very probable upper limit for the foreseeable future and is therefore a significant bit of valuable information.

Summing up, if the USD Index continues to rally, it's likely to be stopped somewhere around the 83 level. Gold, silver, and mining stocks, which are priced in US dollars, move in the opposite direction of the USD Index -- unless we see a strong demand from the non-USD investors. Although the dollar can rally alone, if non-USD demand remains strong, precious metals prices could hold or even increase.


No positions in stocks mentioned.
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