Precious Metals Report
By Leonard Kaplan
Prospector Asset Management
For markets of Monday Nov 18, 2002
GENERAL COMMENTS:
It was a wild ride in the precious metals markets last week as news events, terrorist warnings from the FBI, the unpredictability and concern over Iraqi disarmament, governmental reports on the economy, and fundamental news all rocked the markets. The gold price fell by 80 cents on the week but that belies the volatility seen during the week, with Wednesday seeing December gold futures as high as $325.40, only to crash to $317 just hours later when Iraq acceded to UN demands for inspection. This precipitous decline was almost certainly the result of large speculative commodity funds, who had previously aggressively built long positions, decided to exit the market en masse. These funds, who trade primarily on signals generated by their "black boxes," continue to be buyers at the tops and sellers at the bottom. It is a constant mystery to me why they continue their failed strategies when the results keep coming in poorly.
As an aside, there is a school of thought that you knew everything you needed to know about trading by the age of 4. By then, you knew to touch a hot stove only once, and you knew that if something felt good, you wanted to do it again. It would appear that this lesson still has to be learned by some computer-guided technical trading systems.
The gold market rallied back from the depths on Friday, when a governmental report indicated that the Producer Price Index rose 1.1% in October, far beyond market expectations, rekindling the specter of inevitable inflation. This is only as it should be, the US administration has been expanding the monetary supply at historic rates and has taken USD interest rates to 40 year lows. Also add to the plot, the burgeoning governmental deficit, and the current account deficit, the continuing deterioration in the value of the USD, and inflation seems inevitable to anyone who spent more than 10 minutes awake in their freshman economics class. It is only a matter of time. The gold rally on Friday was also aided, in small measure, to cautions by the FBI that Al Qaeda may be planning "spectacular" attacks within the United States.
Silver, while shadowing gold's movements to a large extent, was largely restrained all last week and gained 5 cents in value. Silver continues to trade within a well-known trading range of $4.52 on the downside and perhaps $4.64 on the upside. Large speculative commodity funds continue to carry outsized short positions and in the words of UBS Warburg, "we continue to believe that a larger short covering rally may be in the offing and that silver remains poised for a move higher." I also sense such possibilities, but it is going to be very difficult for silver to surpass the $4.75 to $4.80 price levels unless gold is able to get through the "brick wall" of resistance at $330 per ounce. Silver is fundamentally hampered by the weak global economy and has, unfortunately, lost much of its "monetary" status or investor interest over the years, thereby limiting its potential. All in all, silver remains a trading market, where it is best to buy dips and sell rallies, unlike gold, where a case can be made for constantly maintaining long positions.
Platinum and palladium were rocked last week by the release of the Johnson Matthey 2002 Interim review of these markets. I will spare you the details of their predictions, but the report expected the platinum supply deficit to widen to almost 500,000 ounces in 2002 as jewelry sales increase in the Far East while palladium demand would continue to fall to its lowest levels since 1994 as deteriorating global economic conditions, large inventories held by commercial users, and technological advances thrifting its use continue. The report, and some comments by their analysts, also cast some doubt that South African producers will be able to accomplish their most ambitious plans in ramping up production. As a result, platinum was up some $16 on the week, while palladium fell by almost $11 in value. I must admit that I see the sharp price movements experienced last week as exaggerated, most certainly in the case of platinum. If the bullishness of the market is banking on jewelry demand, then it makes sense that platinum would, much like gold, have a profile of being rather demand elastic, where offtake falls rapidly as prices rise. But, you cannot fight a trend forever, and if platinum maintains its $600 price level, I would recommend exiting all short positions.
I am constantly irritated that futures trading is characterized by the financial press, and some analysts, as overtly and intrinsically "speculative" in all aspects. Their claim of "highly speculative" relates specifically to the awesome leverage available in these financial instruments. The key word here is "available." As an example, when trading gold futures, a margin deposit of $1350 (about 4% of the current value of the contract) is required, but there is nothing that prevents an investor, or speculator from depositing the full value of the contract, thereby dramatically lessening the risk/reward profile. An investor can buy a futures contract, pay for it in full and, take delivery. In other words, in futures, the investor has the choice of leverage employed in the marketplace and can take positions suitable to his preferred risk/reward profile. The futures and options market is what you make of it, and investments can vary from the very conservative to the wildly speculative.
While, in my opinion, the gold market remains in a secular bull market which will last many years, where fundamental supply/demand characteristics force ever higher levels of support, it is still caught in, what I term, the "jewelry cycle." As about 90% of the demand for gold is for jewelry, and as this demand is highly elastic (where demand falls about 3% for every 1% increase in the gold price), the gold market seems doomed to a slow rise, with each successive trading range being higher than the previous one. (Please note that this is NOT a negative, as the predictability of a market is essential to successful trading). There are many analysts who still, even after years of being proven wrong, forecast a "moon shot" for gold prices. Intrinsic in their hypotheses is the given of investor and speculative demand, as only such buying could create market conditions to force a roaring bull market. But the truth be told, for reasons that I cannot understand, global investors still have not discovered the gold market, even though it is perhaps the performing asset class of the past several years.
Rational analysis would indicate that the gold market will continue higher in the coming years, ratcheting up from one trading range to ever higher trading ranges, but that a roaring bull is still improbable unless gold regains the interest of investors and speculators, which simply has not happened as of yet and, frankly, looks unlikely.
On to the Commitment of Traders reports, as of November 12th, for futures and options combined:
Gold
Long
Speculative Short
Speculative Long
Commercial Short
Commercial
57,696 16,799 74,490 160,221
+18,725 +579 -2,223 +21,245
Long Small Spec Short Small Spec . .
66,084 21,250 . .
+8,796 +3,575 . .
In the relevant week (please note before the massive sell-off on Wednesday), prices rose by $6 and open interest rose by 31,713 contracts as speculative interests piled into the market in force, rebuilding long positions sold out, most probably, at lower levels. Of the 27,500 contracts added by the large and small specs, commercials were most gracious sellers of 23,400. So, for the umpteenth time, we see the commercials profiting from the bullish exuberance of the speculative concerns. The historic analysis of the COTs in this market strongly recommend following the lead of the commercials, as they are most often right in this market, and going against the lead of the speculative concerns, as they are most often wrong.
My view on this market is much unchanged. We remain within a well-traveled trading range of perhaps $315 on the downside to $325 on the upside. As such, the sale of out of the money puts and calls continues to be my favored strategy, while maintaining a core long position. The movements of the USD and the stock markets should continue to dominate the influence upon the gold market.
Silver
Long
Speculative Short
Speculative Long
Commercial Short
Commercial
29,590 16,029 25,940 59,777
+2,952 -6,271 -2,775 +5,536
During the reporting period, silver rose by about 10 cents in price as open interest DECLINED. Again, it is painfully clear that this rally is simply short covering. Historically, silver has not been able to mount a lasting rally on just short covering, which usually can only push price levels just so high. As in gold, commercials were sellers, another somewhat bearish feature.
I look for silver to shadow gold to a great extent, and remain in a rather constricted trading range. The possibility of a significant short covering rally is much diminished as large speculative shorts covered about 25% of their positions already. Again, strategies should be employed to take advantage of this characterization, with options still most advantageous for some accounts. By the way, for those who believe that silver prices will be stable to higher over the next year, the December 2003 $4.25 silver put is trading at 15-16 cents, which seems a most "tasty" trade. If exercised, the investor would be long silver at about $4.10 per ounce, just fractionally above decade lows in the silver price. Please call our offices to discuss this recommendation, as it may not be appropriate for all accounts.
GOLD RECOMMENDATIONS:
Expected trading range $318.50 to $324.50 (positions and recommendations are available to *clients and subscribers only).
SILVER RECOMMENDATIONS:
Expected trading range $4.54 to $4.64 (positions and recommendations are available to *clients and subscribers only).
PLATINUM RECOMMENDATIONS:
Expected trading range $573 to $610 (positions and recommendations are available to *clients and subscribers only).
* A complimentary subscription to the newsletter, with specific recommendations and positions, is available upon request for a one month period.
send emailto: lkaplan@prospectorasset.com |
