Precious Metals Report
Leonard Kaplan
Prospector Asset Management
In my 27 years as a professional in this industry, I must admit that I have never seen such a confluence of bullish factors, both from macroeconomic and technical considerations, as exist in the gold market today.
For markets of Monday June 24th
CLOSES INDICATIVE LEASE RATES
Based on 30 day maturities
AUG GOLD 325.10 GOLD .25/.75%
JUL SILVER 4.855 SILVER .25/1.25%
JUL PLAT 562.70 PLATINUM 3.00/8.00%
GENERAL COMMENTS:
While some malaise continues to pervade the precious metals markets, extremely bullish external forces have dragged prices higher. The USD unrelenting and precipitous declines (down about 2 1/2 cents against the Euro in just one week!!) are strongly prompting global investors to seek safer havens, and the precious metals are the traditional harbor. The USA equity markets continue their most bearish stance, with the DJIA down over 200 points for the week, as values deteriorated rapidly in the latter part of the week. Such rapid and painful declines are literally forcing investors to seek diversification in alternative investments, as staying in the equities markets becomes more foolhardy as each passing week goes by.
In my 27 years as a professional in this industry, I must admit that I have never seen such a confluence of bullish factors, both from macroeconomic and technical considerations, as exist in the gold market today. If just 1/10 of 1% of the global financial assets enter the gold market, that would total approximately 3500 tons of demand, with annual production at about 2600 tons per annum and probably declining in the coming years. I look for a long-term secular bull market in gold, silver, and perhaps platinum as well. But please be advised, bull markets do not go straight up day after day, and investor psychology, blown by the winds of news and events, can and does create large sudden violent declines in prices. And, as the prices of gold and silver edge higher and higher over the coming months and years, I will guarantee that volatilities will increase. To this end, as a trading strategy, it will be imperative to moderate leverage, or gearing, in trading accounts, to take advantage of the high premiums being paid on options (predominantly calls at this time), and to make very sure that one remains resolute emotionally and makes decisions based upon the realities of the market rather than emotional drivers.
While silver slumbered, up only 1 cent for the week, still recuperating from the vicious beatings it survived recently, gold was up $5.50, making its way from under $320 to test technical resistance at $325. Platinum, the preferred purchase of the Far East investor, was up over $7, while palladium fell $6 as continued bearish fundamental news emerged.
In a most ironic turn of economic events, one of the drivers of a lower USD is the "carry trade". In years past, large hedge funds borrowed gold at very low interest rates, sold the gold into the market immediately, and then utilized the proceeds to invest in US Treasury Bills or Bonds, or other financial instruments, at sharply higher rates and then pocketed the difference. Such activities were largely rumored to have forced gold to the very low price levels seen in years past. Now, the reverse is occurring and its use appears to be escalating rapidly. Now, we are seeing hedge funds borrowing USD, selling them immediately and re-investing the proceeds into higher yielding investments where the probabilities of a higher return seem likely. As an example, if you borrowed USD at the beginning of this year, at the then current rate of 2.4% for one year Libor, and invested the proceeds into gold, as of June 1st, your cost of funds were about 1.2% while gold has risen 16% during the relevant period.
At the recent IPMI conference in Florida, there was a great hue and outcry that the gold market both required greater investor involvement and a cost-efficient, reliable, and effective investment vehicle. I strongly agree that investor interest will be paramount in pushing prices higher but I am completely at odds with their opinion that a "new" investment methodology must be created to facilitate the investor. Such an investment vehicle ALREADY exists in the futures markets. Such transactions are highly regulated, all clients accounts are held fully segregated, there is superb liquidity and full transparency, and total transaction costs for BOTH the purchase and the sale (a full round-trip) average about 50 cents per ounce. I cannot imagine a more efficient method for dealing in gold and yet, many of the participants of the conference continue to search out alternative methodologies when the perfect solution is apparent. Perhaps the answer is that most of the major firms represented are not licensed to broker futures and options on futures.
And, the futures industry is soon going to be catering to the small investor as well, as plans exist to begin trading E-MINI contracts in gold and silver in New York. From the information that I have been able to gather, these contracts will be traded electronically, will be 1/4 to 1/5 of the size of the "regular" futures contracts (so silver may be able to be traded in quantities as small as 1000 ounces and gold, perhaps, as small as 25 ounces), and such trading will commence in late summer or early fall.
In one of the most bullish reports that I have seen emerge from a major financial institution, the money management arm of Royal Bank of Canada expects "gold will more than rally, it will explode spectacularly to the upside". Another excerpt from this report is as follows, "The U.S. Dollar has been levitating for a long time, but the underlying fundamentals continue to erode. The US current-account deficit exceeds $400 Billion USD annually, and the continuation of this chronic deficit has turned the US into the world's largest debtor as most of these deficits are being recycled into US debt instruments. Gold is already in a bull market in USD, and an established bull market in every other currency. If the reserve currency, the USD, falters, gold could well be launched on the upside as people recognize its status as the only true currency."
My oh my!! How the world changes and how quickly!! Just one year ago, the old-line financial institutions and the leading economic analysts would have certainly called the insane asylum quickly and made reservations for anyone who harbored such thoughts.
Such paradigm shifts in investment and financial recommendations bring up a critical trading truism. Markets are only about psychology, and the fundamentals of supply and demand are nowhere near as important. The facts of a market are only of minor importance, it is the PERCEPTION of those facts that drives prices and influences markets. Such promulgations of opinion, as noted above, do much to change investor perception.
The socialization of the South African mining industry continues as that government will soon pass a landmark law. Previously, mineral rights were privately owned. Now, they will be governmentally owned and licenses will have to be obtained. And, not only are such license grants, more or less, up to governmental opinions without any clear set of criteria, but they will force a whole raft of rather socialistic or communistic economic sanctions on the industry. Mineral and Energy Minister, Phumzile Mlambo-Ngcuka said that the law was aimed at allowing good quality ore currently in the hands of the big mining houses to pass into black hands. Taking from those who own assets to give to those who do not is either outright theft, sweetened under the guise of redressing old injustices, or blatant socialism. Such actions will most certainly affect the gold production in South Africa in the coming years, perhaps to a greater extent than the market considers at present. Please note that South African gold production has been falling rapidly and now stands at levels last seen in 1954. Look for it to get much worse, and quickly.
The Swiss National Bank continues its program of selling gold into the market. In the last ten days, to June 20th, they sold just a bit under 9 tons total. They have now sold about 529 tons out of the 1300 tons announced and expected by the market.
Palladium has had a rather poor time of late, continuing to drop in price as the other precious metals continue to rise. This week, news had it that the Japanese trade houses, which have been the primary demand for this metal, are not at all anxious to sign long-term supply agreements with the Russians, who produce about 70% of global supply. In years past, the shoe has been on the other foot, with the Russians gamily delaying such offers in order to obtain the best prices. Now that the price has fallen about 70% from its highs late last year, as consumers (especially Ford Motor Co.) sell this metal out of inventories, and as production is slated to rise in South Africa, Japanese trade houses are none too eager to sign 3 to 5 year contracts.
On to the Commitment of Traders reports, both futures and options, as of June 18, 2002
Gold
Long
Speculative Short
Speculative Long
Commercial Short
Commercial
67,896 17,411 65,571 152,308
-3,950 +102 -3,861 -6,544
During the week ended June 18th, the gold market experienced more liquidation of both long and short positions as open interest declined by about 9,500 contracts. Our previous conviction that gold would enter a consolidationary period has, more or less, come to pass as the "froth" of the past weeks markets abates. This is quite healthy and, in our opinion, is a necessary way stop for the bull market. While I still believe that the odds favor a trading range, from about $318 on the downside to roughly $326 or so on the upside, the risk is certainly for higher levels if the decline of both the USD and the US equities markets persist. I would be a comfortable buyer on dips and a reluctant seller on rallies. Selling strangles, which consists of both selling an out-of-the-money puts and calls, seems an excellent trade, as option premiums remain quite high. Please call our offices for specific recommendations based upon your risk profile and account size.
The statistics above indicate the commercials turned net buyers last week as the speculators turned to net sellers. As I strongly believe that the commercials, or those in the trade, know this market much better than the specs, the numbers above would indicate higher prices to come.
Silver
Long
Speculative Short
Speculative Long
Commercial Short
Commercial
50,968 5,045 23,892 96,787
-5,224 +707 +2,618 - -1,447
As in gold, open interest declined during the relevant period as prices slightly declined. Again, this is indicative of a period of consolidation with the market entering into a trading range. Please also note that in this case, the commercials (the trade) were good buyers during the week as the speculative forces were sellers. I like that a lot. Historically, the trade takes money from the speculators a large percentage of the time and I much prefer the long side of the market given the above information.
As in gold, I look for a trading range with the risks on the upside. Silver has been slavishly following the gold market of late, although, in some cases, with greater volatility. I would imagine this trend would continue. Look to be a buyer in the $4.82ish range and a seller in the mid $4.90's.
Since option premiums in silver are so lucrative at present, I would also be a naked seller of put options and a covered seller of calls.
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