March 28, 2004
For markets of March 29th

Drawing on such external stimuli as heightened fears of terrorism and other factors to be discussed below, large and small speculators continue to add to their precious metals positions, pushing gold up $9.50 for the week, silver by about 15 cents and platinum surged higher by $22 per ounce. Most analysts attribute this recent weeks rally in the metals to the recent sharp increase in global geopolitical turmoil, but perhaps there is much more to this. While I do not mean to disdain this rationale, I do not see it as the primary moving force for these markets.

I have often written that the first leg of the bull market in gold, over the past few years, has been strictly and solely based upon the USD, and the correlation of gold to the Euro has been tracked as being 91%, a ratio that denies any doubt that gold was simply a negatively correlated proxy for the USD in foreign exchange markets. And, I have written that the next leg in the gold bull market will begin when the gold price begins rallying against all, or most, currencies. And now, almost right on time, we have seen gold rally mightily even as the Euro fell (about a cent and a half), and the USD rose fractionally. Gold is now rallying against all currencies, a most bullish phenomenon. The very key question is whether this is the start of something really important, or is just a short-term aberration of the trend that has lasted for years. Truth be told, I am not sure as of yet. But, if the gold price moves above $430 while the USD remains strong, I would be a total believer. 

As an aside, my clients in Europe and Asia have been none too impressed with the gold market over the past few years as its performance has been strongly muted when they convert the gold price back into their local currencies. If gold starts to rally in their OWN CURRENCIES, I see a cadre of new and fresh buyers, with oodles of capital to spend, coming into this market. With the large US speculative funds already strongly committed to his market, with just about everyone in the USA bullish (meaning that they have already bought), it is going to take fresh, new buying to propel the gold price towards my year-end goal of $480-$500. The divorce of gold from the Euro and the foreign exchange markets is very important, and could be, but not certainly is, the driving force for a solidly based second leg of the bull market in gold. 

What few analysts have mentioned, and what I believe could be the paramount stimulus to the precious metals markets is the old bugaboo, inflation. Although it was COMPLETELY obvious to all that inflation was almost rampant despite the coddling statistics put out by the US government, the financial markets were totally unaware, completely oblivious to this almost certainty. All of a sudden, in the last week, inflation fears suddenly hit the cognitive brains of many traders. The most sensitive barometer of inflation is the US 30 year bond, which broke through major support and closed some 1 and ½ points lower, pushing interest rates yields higher. The monster of inflation suddenly moved from its habitat in some dark corner of the cellar to sit with the family at the dinner table, devouring an increasing higher percentage of the feast.

While it has been a very long time, most of us firmly acknowledge that “hard assets”, including precious metals have been extremely sensitive to both the fears, and the reality, of inflation. Inflation was the PRIMARY mover of the bull market in the precious metals during the late 1970’s and early 1980’s, and perhaps, just perhaps, this is the reason why the gold market is moving higher, irrespective of the its past currency affiliation. While Wall Street and the financial markets arena embrace a new “flavor” almost every week, it is just possible that inflationary fears have been, and will be, the driver to ever increasing precious metals prices. But, it’s still a bit early to be sure.

On the front page of Sundays Chicago Tribune was the following headline, “Prices rising despite low inflation rate”. I must admit that upon reading it, I chortled like a banshee being tickled. It was just too “Orwellian”, too much like reading the book 1984 where the psychology of the populace is engineered by the government by use of the language. So, I guess we don’t have inflation, we just have rising prices. Next time I get caught by a policeman for speeding in my car, I will carefully explain that I was not speeding; I was just exceeding the posted limit. Wish me luck.

Yes, the paragraph above amuses me, but the point is that now; finally, perhaps the realization of inflation is entering the psyche of the financial marketplace and investors. Such stories are NOW on the front pages of newspapers and financial publications. With the twin deficits of the USA at over 9% of GDP, with the costs of the wars in Iraq and the fight against terrorism, and with the USD down some 30+% in just two years, it was totally expected. And this, I believe was the primordial force pushing the precious metals market higher this week. But, in my new found realization that I must be politically and semantically correct (tee hee!), I hereby state that I am not bullish on the gold price, I just expect prices to rise.

Silver, true to its recent nature, had a trading range of 40 cents from low to high for the week, some 6% of its total price. Prices careened wildly in this thin market as orders from the large speculative funds dominated the price action. Anecdotally, the physical market is poor, with investor and commercial offtake still remaining anemic, at best. One of my clients, a refiner, is being offered 10 times the amount of silver per week than just several months ago. But, it is totally meaningless with the 100 lot or 300 lot orders being thrown around on the floor of the exchange. Trust me; all the action is highly frothy and speculative. Net Comex silver positions are at or near all time highs. This makes the market highly vulnerable to a sharp sell off but does not speak of when it could occur. All depends on the willingness of the funds to hold on to, or add to, their positions. Historically, the silver market suffers from extraordinarily sharp retracements after rallies of size, and I would guess it is going to happen again (in 1987, I saw silver go from $11 to $7 in just hours). But, the momentum is still higher, the funds are still buying, and my guess is that we still go higher.

Even with gold prices near multi year highs, it would appear that physical buying of the metal is much better than many expected. In India, the foremost demand center, gold and silver imports have climbed 42% in 8 months. Historically, the Indian populace has been reticent to chase higher prices, but now they seem ready, willing, and able to buy. Surely a rising rupee and a good monsoon season, thus a good harvest, has helped. Next, imports of gold into Japan rose 319% in February, year on year, to a bit over 6 tons. Now, 6 tons is still next to nothing, but is perhaps indicative. I strongly believe that the gold market is very well supported here, and that any declines we might see are superb buying opportunities. I think the chances of seeing prices under $380 are truly microscopic almost no matter happens. This is an excellent time to sell put options into this market and recommendations will follow. I would, obviously, be a buyer of dips in this market.

Lastly, before we delve into the Commitments of Traders reports, we have yet another example of “newspeak” (from the book 1984 by George Orwell as mentioned above). In the same week, Norilsk, the largest producer of palladium in the world, first predicted that this metal would trade to $350 per ounce by the end of 2004, and also released sales results showing that they have been HEAVILY discounting the palladium price to long-term industrial users to get the metal sold. According to Mineweb, the implied sales price was $194 per ounce, basis the current price of about $290. Well, I guess that this is nothing new from the Russians as it relates to platinum and palladium production and sales, as the market always believed that anything they said was a lie anyway.

The Commitment of Traders reports, as of March 23^rd, for both futures and options:

As gold prices rose some $18 in the reporting week, open interest rocketed up by about 76,000 contracts. As the data above shows, the rally was totally fueled by long speculative forces adding heavily to their positions in the market.  Their purchases were accommodated by the commercial shorts, demonstrating the increase in their inventories or similar commitments. The ratio of spec longs to spec shorts is now 4.7 to 1, approaching a dangerous imbalance in this market. But, over the past months, the longs have shown remarkable fortitude in their positions, and have not been scared out even on sharp declines in the price.

From a technical perspective, with gold near its recent highs and with significant resistance overhead, it is going to be most difficult to log further significant gains. We will need gold to CONTINUE to rally in all currencies, we will need further buying from investors and speculators in Europe and Asia. If anything, at this point in time, I remain rather neutral to very slightly bearish. I would rather be a buyer on dips in this market. However, a convincing breakout above new highs at $430 must be followed.