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A look at what may be in store for precious metals and precious metals miners in the year ahead.

No follower of metals markets will be unaware that the past year has seen tumultuous volatility in metals prices and mining stocks, and many will have had their fingers burnt drastically in the shakeout we have seen over the past few months.  What has been the real shock has been the speed of the price downturn once it started which reduced many mining stock prices to a fraction of their prior worth in a matter of weeks.  That the fall-off has been overdone there is little doubt – indeed those who picked the market bottom for most mining stocks (probably around mid-October) could have made a welcome turn as many metals commodities-related stock prices have doubled or better in the past two months, although nearly all still remain at a fraction of their peak prices achieved earlier this year or last.

But what can we expect in the weeks and months to come?  A continued recovery – or a return to the lows seen in early October?  The scenario is horrendously difficult to predict – but perhaps that has always been the case.  But we can expect precious and industrial metals to perform rather differently given the former – or at least silver and gold – have a monetary and investment element in their price movements while the latter (and one has to include the platinum group metals in the industrial sector here) are ultimately price dependent on the state of industrial supply and demand – and even predicting where this will lead us in the months ahead is well nigh impossible given the current global economic picture and the uncertainties surrounding consumer confidence in the year ahead.

GOLD

Gold has been one of the best performers in the general market crash seen in the past nine months.  True it is well off its peak achieved back in mid-March, but a fall of only 15 percent between then and now can be seen as a pretty creditable performance in wealth maintenance terms.  The metal price is actually higher at year end than at the beginning and not many commodities will have achieved this accolade!  True this is hugely short of the gold bulls' predictions of a massive rise in gold price on financial turmoil and political unrest – which they still predict – but the more cautious analyst would see gold primarily as both a hedge against inflation and deflation and also a reflection on the perceived strength, or weakness, of the US dollar rather than a vehicle for making quick and large profits.

In these terms it may be necessary to take a relatively cautious viewpoint on gold.  The recent heavily reported surge in demand for physical gold is not necessarily because people are looking for huge gains in price, but primarily because of the lack of trust in banks and investment institutions and a protection against possible failures in these sectors.  In the current climate wealth preservation is the primary aim of most people – not necessarily wealth growth, although in a deflationary scenario, which some anticipate, these can amount to much the same thing.

There is obviously the possibility of good gains as well, but this should be seen as a bonus if it should happen, rather than a likelihood.  There is also the continuing possibility that the gold price will fall back in the months ahead, particularly if the general markets see a new downturn.  But the consensus is that if the gold price does fall back the downside potential is much more limited than that for the stock market as a whole.

SILVER

Silver is a bit of a different animal, but does tend to ride on gold's coat tails – but in a far more volatile manner given its production patterns and industrial usage.  Unlike gold, silver fell back 57 percent from peak to trough and will likely continue to be far more volatile than gold in the months ahead.  If gold does surge, then silver may do even better in percentage terms.  If gold falls there is the possibility silver will do even worse.

To an extent silver as a commodity is a bit of a red herring – or it is at the moment.  While more and more uses are found for the metal in emerging communications and bacterological fields and supply may well be primarily dependent on byproduct output from zinc and lead mining, where huge closures are taking place, the main drivers remain in its position as an investment vehicle and in the jewellery market.  Price movements remain very much tied to gold and it is in the performance of the latter where sliver's potential for price increase, or decrease, really lies – despite the views and the protestations of the true silver bulls who are, perhaps even more evangelical in their outpourings than the gold protagonists.  If you have a positive  view on gold, then buy silver and hang on for the roller coaster ride could be the path here!

Overall I suppose one should be cautiously optimistic on the outlook for gold and silver in the year ahead.  Gold fundamentals look relatively strong and prices seem to be well supported above the $740 mark which should limit the downside risk.  Upwards the sky would seem to be the limit, but the reality is that gold has moved pretty cautiously through the recent financial quagmire and is likely to continue to do so.  $1,000 gold still has to be in prospect sometime in 2009, and once reached may well be maintained, particularly if the dollar starts to fall again.

The worry here though is the oil price – another element which has traditionally had an effect on the gold price where the historical price relationship has tended to be around 10:1.  Current oil price levels would suggest that gold is overvalued!  Or perhaps it is that the oil price is way too low given the current price of gold.  The latter may well be the case and as with base metals one suspects the fall in the oil price has been overdone and with the proposed OPEC cuts one should not be too surprised if 'black gold ' returns to the $70-80 level before too long.

PLATINUM GROUP

Then there are the in-between metals – notably platinum and palladium – the former having suffered one of the biggest falls of all during the past year.  It was initially buoyed by the assumed ever-continuing supercycle, coupled with a power supply crisis in South Africa which was restricting supply and the platinum price rose dramatically on supply fears in what was already likely to be a supply deficit year anyway.  But the price fall was dramatic as auto sales collapsed in the second half of the year on global economic paralysis following the banking collapses, huge governmental bailouts and a generally very pessimistic view of the short to medium term economic picture.  With auto catalysts accounting for by far the bulk of platinum use, there is unlikely to be a serious pick-up in platinum price until the true auto (and platinum) demand picture is clarified in the months ahead.  For the moment platinum seems to be stuck at a level marginally above or below the gold price and this could well continue for a few more months, depending on where gold goes from here.  This has happened before.  But any discount to gold may be shortlived once global industrial output begins to pick up with most specialist analysts predicting a return to plus $1,200 platinum in 2009.  It would not take much of a movement to get it there.

Palladium seems to be in a different position.  Supply was in surplus prior to the auto industry nosedive and the price looks as though it remains vulnerable with little upside potential on the fundamentals front.  However, global supply is largely dependent on Russian exports and these could be cut off if the Bear sees it to be politically or financially advantageous.  The West's largest primary palladium producer – the Russian owned U.S. miner, Stillwater, is struggling at the current palladium price and is already having to close down sections of its Montana operations as uneconomic.  Unless there are, indeed, curtailments in the supply position, palladium's short term does not look promising.  Longer term it looks better as it continues to erode away platinum's usage in autocatalysts, but this is a slow process.  Marketing is also being put into the palladium-as-jewellery sector, but here again progress is slow and the take-up of physical metal is not that significant in the overall picture.

ETFS

Exchange Traded Funds – particularly those for gold and silver – have been an extremely positive element in soaking up any excess supply and have remained remarkably strong throughout the period when it seemed that cash-starpped funds were having to offload almost any investment to generate sufficient cash to stay alive.  ETFs thus can provide both a bonus and a potential pitfall for the precious metals investor, with a huge amount of gold and silver held in these funds overhanging the market.  At current levels they are likely to provide a damper on upwards profit potential with profit taking limiting metals price gains on the way up.  If there ever is, though, a general perception that precious metals prices are likely to fall, which would start driving the market downwards, then sales from ETFs could accelerate the process in a nightmare scenario for the investor.

Platinum ETFs though have proved to be ratrer more volatile and there is a strong feeling that sales form these, in what is a much smaller and tighter market than for gold and silver, have tended to exaggerate the price declines and are at least partially responsible for platinum falling as low as it has.  Conversely there is a current perception that those buying platinum ETFs now see investment at current price levels as purchasing at or near the bottom and are thus likely to hold their investment more strongly in the short to medium term.

PRECIOUS METALS STOCKS

There is a strong perception that virtually all mining and metals related stocks were oversold by mid-October and many have bounced back spectacularly since then.  The willy nilly selling in late September and early October dragged the good stocks down virtually pari-passu with the mediocre and the rubbish and those who have done their due diligence picking stocks which had good geological potential and sufficient acccess to funding to survive a prolonged recession could have made a killing!  Actual gold producers can still record good cash flows – particularly given that, as pointed out at the beginning of this article, the gold price is higher now than it was at the beginning of the year.

Another positive to take into account is that the enormous rising cost pressures which had been afflicting the whole mining sector have been reversing, while for the developer potential capital equipment shortages have been eased and prices of both equipment and engineering services have been falling back fast now that supply probably exceeds demand in most parts of the world.

Overall, the precious metals sector has probably seen the worst of the downturn, and has weathered it better than most others.  Upside potential may still be limited though in the months ahead failing any significant metals price movements.  Investors, unless one goes for true high risk players, should probably avoid operators in politically risky environments and those in a precarious financial situation.  Even acquisitions here are unlikely to be on particularly favourable terms for an investor.

For those mining companies with access to funding there are most certainly still good opportunities out there for acquiring interests in good deposits at low prices.

Platinum though remains in the doldrums, but perhaps has been oversold and longer term potential, once the auto industry begins to recover, looks relatively strong, but it may yet be some time before prices rise sufficiently to make some of the next generation of mining operations profitable.