Food for Thought
Gold Mining Outlook
by Steven Jon Kaplan
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The latest traders' commitments are in--see below.
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Updated @ 5:20 p.m. EST, Friday, February 27, 1998.
COMMENTS OF THE DAY: Commodities, including precious metals, continued their recent rally on Friday. Though the prices of most precious metals are virtually unchanged from my last update two weeks ago (except for a new multi-year high in rhodium), their recent retracement and recovery combined with increasingly bullish traders' commitments are likely to be setting the stage for a significant rally. Notice that the $290 level has been continually retested, whereas $310 has not yet been probed; the path of least resistance is likely to be up, particularly if the Dow rally shows signs of faltering. Gold gained $4.70, silver surged 27.7 cents, platinum was up one dollar, and palladium bucked the trend by dropping $7.65.
By the end of 1997, outstanding central bank gold in the market on swap or deposit probably exceeded 3,700 tonnes (1-1/2 years of total worlwide mining supply), according to Gold Fields Mineral Services.
French central bank governor Jean-Claude Trichet, who is one of the leading contenders to be the first governor of the new European Central Bank (ECB), made unequivocally bullish comments about gold in an interview with Central Banking magazine. "We have no intention of selling any gold, or in any way downplaying the role of gold as a reserve asset. Gold is a very important element in the credibility of the currency in the eyes of our people. It is one of the elements on which confidence in the currency is based, particularly in the eyes of public opinion. It is often viewed as the ultimate reference asset."
On the New York Stock Exchange there were 243 new highs and 21 new lows, with 1532 stocks advancing and 1329 stocks declining. The index put-call ratio was a moderately pessimistic 1.66, while the equity put-call ratio was a modestly pessimistic 0.45.
The volatility index, a measure of implied volatilities for U.S. stock index options which demonstrates complacency vs. fear in the market, closed up 0.25 at 19.43. On Wednesday, February 25, 1998, the VIX hit an intraday low of 18.69, its lowest level since January 23, 1997 (more than one year ago). The VIX has been below 25 since January 16, indicating a lack of investor concern about a drop in the stock market.
Friday's COMEX gold estimated volume was a moderate 43,000 lots. Total COMEX gold open interest on Thursday fell 683 to 181,608 lots, which combined with recent open interest data indicates that commercials are increasing their buying especially below $300 spot as they are anticipating that prices are not likely to significantly decline. COMEX gold warehouse stocks were unchanged at 480,910 ounces, while COMEX silver warehouse stocks rose by 534,177 ounces to 90,095,264 ounces. Implied gold lease rates are 2.15% for one month and 2.00% for one year. Such an inverted condition demonstrates that short-selling speculators are more eager to borrow the metal than producers are eager to lock in current prices for future output, a classically bullish indicator. The Johannesburg gold index closed Friday morning at 782.1, up 44.2, with the U.S. dollar quoted at 4.9390 rand.
I will attempt to give an unbiased outlook on the intermediate-term prospects for worldwide gold mining shares, based upon a collection of the most important fundamental and technical indicators. The objective will be to indicate critical turning points in the market. The indicators are listed in order of importance, most important first. Information in boldface has been recently updated.
The current outlook is STRONGLY BULLISH, primarily because of strongly bullish traders' commitments for gold and slightly bearish traders' commitments for the "white" metals; a generally neutral and rapidly improving technical chart for the yellow metal as it continues to retest its 1985 bottom, with a break of the downward trendline connecting the peaks on a weekly chart from the first week of February 1996 increasingly likely as it coincides with the past of least resistance, and which would be strongly bullish; generally pessimistic analysts' and investors' behavior, as evidenced by the powerfully negative comments about gold in late February each time that it had a moderate down day; a powerful correlation between the early years of a major worldwide bear market in equities and a corresponding sharp rise in precious metals, with the recent Dow rise coupled with rising long-term U.S. Treasury yields making a decline from the stock market's peaks increasingly likely, and having a powerful correlation with a weaker dollar which is classically bullish for gold. An increasing army of short-selling speculators have been unable to push gold below $300 for any sustained length of time, and they are surely sitting with tens of thousands of contracts of buy stops not far above $300.
RECENT CHANGES:
Friday, February 27, 1998: The traders' commitments indicator, the single most important factor for gold, has climbed from MODERATELY BULLISH to STRONGLY BULLISH.
Friday, February 27, 1998: The price/volume statistics indicator has been raised again from SLIGHTLY BEARISH to NEUTRAL.
Friday, February 27, 1998: The other precious metals indicator has climbed from MODERATELY BEARISH to SLIGHTLY BEARISH.
Friday, February 13, 1998: The price/volume statistics indicator has been raised from MODERATELY BEARISH to SLIGHTLY BEARISH.
Friday, February 13, 1998: The other precious metals indicator has fallen once again from SLIGHTLY BEARISH to MODERATELY BEARISH.
Friday, January 30, 1998: The traders' commitments indicator has dropped from STRONGLY BULLISH to MODERATELY BULLISH.
Friday, January 30, 1998: The other precious metals indicator has declined again from NEUTRAL to SLIGHTLY BEARISH.
Friday, January 16, 1998: The other precious metals indicator has slipped from SLIGHTLY BULLISH to NEUTRAL.
TRADERS' COMMITMENTS (COT):
One of the most important factors affecting the market is the traders' commitments as reported every second Friday by the COMEX. These commitments tell you what the commercials, or industry insiders, are doing vs. the non-commercial outsiders, also known as speculators. If the insiders, such as producers, jewelers, fabricators, and industrial users, are buying, while the speculators are selling short, this is BULLISH. If insiders are selling as fast as they can, while speculators are buying left and right, this is BEARISH. In any business, especially in commodities, people in the thick of things obviously know much more about the supply/demand situation than people who have no connection to the industry and are just trying to get rich quickly.
As of February 24, 1998, released at 3:30 p.m. on February 27, 1998, the commitments for COMEX gold futures show commercial insiders long 112,478, short 81,205; speculators long 13,023, short 46,469. The average historic ratio for commercials is 2:3 long to short; for speculators, 2:1 long to short. Therefore, commercials are substantially more long than usual, and speculators are substantially more short. These values became significantly more bullish over the past two weeks, and combined with open interest data released since Tuesday, this indicator has been raised to STRONGLY BULLISH.
COMMODITY INDICES:
There is a strong correlation between commodity indices and the price of gold, which makes sense since gold is a proxy for all commodities. It is often said that the price of a good quality men's suit has always been equal to the price of one troy ounce of gold. This doesn't say, however, whether you got your suit on a markdown sale, or whether you prefer to shop at Brooks Brothers or at K-Mart. A quick check at Barney's showed their executive suits averaging about $600, so this is bullish for gold. (Either that, or the price of men's suits is about to undergo a dramatic collapse!)
The Journal of Commerce (JOC) index is a basket of seventeen raw industrial materials used by the U.S. factory sector. It is designed to signal upcoming trends in the government's consumer price index by 6-9 months or more in advance. It is not nearly as publicized as its counterpart, the Commodity Research Bureau (CRB) index. Whenever the JOC is going in one direction and the CRB in another, the JOC has been more accurate historically in predicting a rise or fall in future inflation. This value will usually be reported with a one-day delay. On Thursday, February 26, 1998, the JOC index closed up 0.12 at 95.53, continuing its recovery from Tuesday's level of 95.09, its lowest closing value since March 1994.
On Friday the CRB index touched an early morning low of 226.14, then rose to a mid-afternoon high of 227.77 before closing up 2.03 at 227.65. The 240 level marks important resistance. Both the JOC and CRB indices have been in a long-term upward trend since August 1992.
This indicator is MODERATELY BEARISH.
GAUGES OF FUTURE INFLATION:
The Economic Cycle Research Institute (ECRI) future inflation gauge (FIG) for January, released February 6, 1998, was at 107.6 compared to an upwardly revised 108.8 (was 108.4) for December. Its smoothed annualized growth rate fell from -1.5% (was -2.0%) to -3.7%.
The Columbia University Center for International Business Cycle Research (CIBCR) monthly leading inflation index, released February 6, 1998 for the month of January, was measured at 101.8 after having been 103.3 in December (revised upward from 102.8). Its smoothed semi-annualized growth rate dropped from -1.7% (was -2.4%) to -4.3%.
This indicator is SLIGHTLY BEARISH.
WORLWIDE INTEREST RATE POLICY:
Gold must always compete with time deposits as a short-term investment. Therefore, as interest rates rise, there is more to lose by being invested in the yellow metal rather than in an interest-bearing instrument. As interest rates fall, there is less to be sacrificed by being invested in gold. The recent volatility in financial markets in the U.S. and abroad will make it much more difficult for the Fed to raise short-term interest rates, though it is unclear whether they will be able to lower them given the strong U.S. economy and year-over-year wage gains remaining at about four percent, coupled with a tight labor market. Worldwide concern about high unemployment seems roughly balanced with inflation vigilance, creating a general stalemate.
On Friday, January 30, 1998, the Bank of Canada raised its key bank rate by 0.50% from 4.50% to 5.00% in order to support its currency, which on Thursday had fallen to its lowest level against the U.S. dollar since its creation in 1858. On Friday, February 13, 1998, the Bank of Spain lowered its benchmark interest rate by 0.25% from 4.75% to 4.50%.
This indicator is SLIGHTLY BULLISH.
INSIDER STOCK TRANSACTION ACTIVITY:
If an officer of a corporation is buying stock in his or her own company, it is a strongly bullish sign, since such a person would logically be the most familiar with the actual profits and losses, as well as pending projects and other relevant news. Similarly, if a corporate insider is selling, even if the stated reason is to pay for a child's college education, it is clearly a reason for turning bearish, since that person has rejected this investment in favor of another course of action. The higher ranking the corporate insider involved, the more emphatic the signal, since the more knowledgeable such a person would be with the entire outlook of the company.
On Tuesday, January 20, 1998, a small purchase was announced by a director of Hanover Gold Co., Inc. On Tuesday, January 20, 1998, a small purchase was announced by a vice president of Alta Gold Co., Inc. On Tuesday, January 27, 1998, a small purchase was announced by a director of Homestake Mining Co. On Friday, February 13, 1998, a very small sale was declared by the president of Nevada Manhattan Mining Inc.
This indicator is SLIGHTLY BULLISH.
OTHER PRECIOUS METALS:
The behavior of silver, platinum, and palladium can serve as an early signal for gold, since these metals often rally or decline first. As is typical, silver continues to be more volatile over the short run than gold. After trading in early December 1996 at a very small discount, spot platinum reached a huge premium to spot gold as it hit a new 7-year high in August 1997, then declined almost all the way back to its 1985 low in December 1997 before recently rebounding once again. If nothing else, this certainly debunks the myth that sentiment about any particular commodity is unlikely to change rapidly over a short period of time! Palladium has been rallying the most sharply and consistently since Tuesday, December 31, 1996. Silver made an upside breakout in late 1997 and again in 1998. Both platinum and palladium also made upside breakouts in 1997, with platinum reaching a 7-year high and palladium soaring to a new 18-year high of $251.50 per ounce on January 15, 1998. Since all precious metals are subject to significant common fundamental factors, the multi-year highs that were set by palladium, platinum, and silver will eventually be enjoyed by gold once the enormous short-term combined downward pressure of gold loans and gold short selling is unwound.
The traders' commitments for these three metals as of February 24, 1998, released at 3:30 p.m. on February 27, 1998 varied widely, though they all improved from their levels of two weeks earlier. For COMEX silver futures, commercial insiders were long 13,306, short 71,291; speculators long 51,662, short 5,541. This means that the commitments for silver remain extremely bearish, though have improved slightly compared with two weeks ago. Looking at NYMEX platinum futures, commercial insiders were long 3,767, short 8,191; with speculators long 3,715, short 957, which is moderately bearish for platinum, a significant improvement from extremely bearish two weeks ago. For NYMEX palladium futures, commercial insiders were long 2,501, short 3,285; and speculators long 1,451, short 761. This is slightly bullish for palladium, compared with neutral two weeks ago.
Because of an across-the-board improvement in the traders commitments for the white metals, this indicator has climbed from MODERATELY BEARISH to SLIGHTLY BEARISH.
PRICE/VOLUME STATISTICS:
On Monday, January 12, 1998, the XAU touched 61.23, its lowest point since July 31, 1986. The XAU is thus forming an extended triple bottom from the bear market lows of July 25, 1986 (58.72) and November 27, 1992 (64.38). Since February 1996 the XAU has been in a general downtrend, though momentum has improved dramatically since January 12, 1998. In November 1997, December 1997, and January 1998, virtually all gold mining shares hit new annual lows. Recent developments will be watched closely to see if the downward trendline can be convincingly broken, which could signal an upside breakout. This indicator has been raised to NEUTRAL due to the significant attempt by the XAU to complete its long-term triple bottom. A convincing rally from this point would establish the triple bottom as a bullish long-term technical base. The action in late February, consisting of another drop followed by a recovery, strongly supports the completion of the triple bottom in preparation for a move in the upward direction.
Silver touched $7.500 in the active March 1998 contract at 7:22 a.m. EST on Friday, February 6, 1998, the highest level for the active COMEX silver contract since July 25, 1988. Silver had previously made a bullish key reversal on Thursday, July 17, 1997, by touching its lowest point since October 1993 in early trading, and then rallying to end the day with a net gain. The silver/gold ratio continues generally to increase as the "poor man's gold" has steadily outperformed its yellow cousin since its generational bottom in the first week of February 1991 during the Gulf War. Platinum, palladium and silver thus all made upside breakouts in 1997; palladium and silver once again in 1998. Gold broke below its 1985 lows, and is retesting levels from 1979, gold's strongest rally year to date. At 8 p.m. EST on Monday, January 12, 1998, gold touched $276.50 per troy ounce, its lowest spot price since June 28, 1979. Lately, gold has recovered several times from early morning price dips, typical bullish intraday behavior, while it has not seriously tested the $305 level. Repeated downward moves have been rejected, so the path of least resistance seems to be upward. Gold has temporarily stabilized in price after its January bounce, while commercials have been steadily accumulating the yellow metal, especially on each price dip below $300 spot, indicating that they have raised their price expectations. Repeated failures by an increasing army of short-selling speculators have failed to succeed in keeping the price significantly below $300, indicating that the path of least resistance is likely to be upward, with $310 as the next likely target to be tested. Therefore, this indicator has been upgraded to NEUTRAL.
Total gold mining equity option U.S. daily volume is roughly at normal levels while put-call ratios are also roughly at normal levels. This is NEUTRAL.
Synthesizing these three signals as a group, the price/volume statistics indicator has been raised once again to NEUTRAL.
XAU "MAGIC MULTIPLE FIVE":
The XAU is a weighted index of large-capitalization gold mining shares, with management primarily based in Canada and the U.S. There is a historical correlation between the behavior of the XAU as it approaches or crosses any multiple of five, and the short-term future performance of the XAU. The most bullish behavior is if the XAU begins the day above a multiple of five, goes below a multiple of five during the day (particularly if the intraday low is the lowest level in several weeks or more), then closes the day with a gain. The most bearish behavior is the exact opposite. On Friday, February 27, 1998, the XAU opened slightly higher at 73.99, edged down to an early morning bottom of 73.91, then rallied to a mid-afternoon top of 75.58 before closing up 3.57% at 75.45. Since the key level of 75 was broken and held to the upside, this is SLIGHTLY BULLISH.
PAGE ACCESS:
Similar to the way that some count advertisements in business publications or a survey of investor sentiment as a useful contrary indicator, consider the number of times this page is visited on a daily basis. If that number is less than 800, gold mining has become boring, which is generally bullish. If more than 1600 people access the page, the market is overexcited, which is bearish. Currently, there are about 1100 visits per business day, based upon reliable hourly samplings. This is NEUTRAL.
SPECIAL POLITICAL CONSIDERATIONS:
Since the Presidential election is over, there is no incentive for the government to prop up the stock and bond markets or to depress the prices of precious metals. In fact, the government would like the markets to perform poorly now, so that they can rally just before the election in the year 2000.
GENERAL COMMENT ON THE STATE OF THE FINANCIAL MARKETS:
In 1982, as interest rates, crude oil, and commodities were finally declining from cyclical highs, investors were bailing out of mutual funds at a record rate, convinced that stocks were "stupid" (they had lost three-quarters of their real value in the previous 16 years). Money surged into bank CDs, money markets, and hard assets. Today, as interest rates, crude oil, and commodities are finally rising from cyclical lows, investors are pouring into mutual funds at a record rate, convinced that stocks are "the place to be". Money is surging out of bank CDs, money markets, and hard assets. Investors are truly inveterate followers of the thundering herd. Assuming that profits and dividends of U.S. corporations continue to grow at the same average rate that they have grown for the past thirty years, or even one hundred years, the stock market will decline by 82% by the next bear market bottom assuming that the dividend yield at that point is 7.5%, the U.S. historic average. If one assumes that this will occur between the years 2000 and 2010, it would imply an inflation-adjusted decline of between 91% and 96%. Should the dividend yield exceed 7.5%, which it is likely to do since panic bottoms often follow euphoric tops, the inflation-adjusted drop could exceed 97%. (Note to skeptics: The Hong Kong stock market declined by 97% during the 1973-1974 bear market, and in past post-euphoric eras, a 97% fall was not unusual for markets as well established as London, Paris, and Amsterdam.) Those who have been following developments in third world bourses may have noticed that many of them declined by more than two thirds (in U.S. dollars) in just a few months, and some by more than 80%, in spite of their economies having a higher GDP growth rate than the U.S. economy for two decades or more, and with no significant political or economic crises that "caused" these huge falls other than the same blatant historic overvaluation that can be found right here in the good old U.S.A. It has been a wild party, and the stock market a most gracious and generous host, but it's time to go home before you are trampled by the herd rushing to leave.
Call it the "family and friends" indicator--how many people do you know who recently put their money in the stock market after years of indifference and/or insistence upon safe investments?
REPORTING FROM THE EUPHORIC ZONE--Guaranteed true footnotes to the baby boomer bubble (a.k.a. "tiptoe through the tulips"):
According to the New York Times "Week in Review", page 2, of Sunday, February 15, 1997, the total value of stock market shares held by U.S. residents exceeds the total value of all real estate held by U.S. residents.
According to a year-end survey by Adweek magazine, 77% of U.S. investors predicted a continuing bull market in 1998, compared with only 7% who were bearish.
According to the front page of the New York Times business section on Wednesday, October 22, 1997, a survey by Montgomery Asset Management of San Francisco found that the median expectation for current investors in U.S. equities is for an average annual gain of 34 percent for the next ten years, the highest in any such survey in history, and surpassing the previous record of a 22 percent anticipated annual gain in a virtually identical prior survey by the same pollsters in early 1997.
The number of U.S. listed mutual funds substantially exceeds the number of U.S. listed stocks, with more mutual funds being added every month.
In late June 1997, the State of New Jersey finalized plans to borrow 2.8 billion dollars at an interest cost of 7.6% and an up-front fee of fifty million dollars in order to invest the money in U.S. equities.
LONG-TERM (ONE- TO THREE-YEAR) OUTLOOK:
The price of gold exceeded $420 an ounce in 1989, 1990, and 1991, but could not close above $425 in either year. In 1988 the yellow metal briefly touched $500. Therefore, once gold closes above $425 an ounce, this event will trigger an upside breakout causing the price to surge rapidly to $500. Notice that exactly this kind of upside breakout occurred in 1997 first in palladium, then platinum, and finally in silver. As euphoria begets euphoria, the stock market blowoff will also act as a stimulative spur to increase the likelihood of such a move happening in gold. The resulting public attention and likely insider selling will cause a counter-reaction, causing it to retreat all the way back to $380 before rallying again.
When gold reaches $500 an ounce, the XAU will make a euphoric top around 270. This will happen three to nine months after the S&P 500 begins to decline. The subsequent drop to $380 will cause the XAU to make an intermediate-term bottom near 130. That will occur as stability is temporarily restored to the general equity markets. (Since platinum touched $500 per ounce in 1997 and then fell back, this makes a useful technical guide for gold.)
VERY LONG-TERM (FIVE- TO TWELVE-YEAR) OUTLOOK:
In January 1980, spot gold traded at $850 per troy ounce while the Dow Jones Industrial Average was about 800. As of 10:57 a.m. EST on Tuesday, December 9, 1997, the Dow was at 8074 while gold was at $281, making the Dow worth over 28.73 ounces of the yellow metal--a record since the price of gold was allowed to float in 1973. As the bear market approaches its inevitable nadir sometime in the next decade, we might see the Dow at 1850 (dividend yield 7.5%, indicating a moderately severe bear market bottom) and gold at $1000 per ounce (adjusted for inflation, equal to its average price from 1979 through 1983). Since panic bottoms often follow euphoric tops, and vice versa, one could imagine the Dow at 1485 (dividend yield 9%; it was 11% in July 1932) with gold at $1500 per ounce (adjusted for inflation, its January 1980 peak will top $2000 per ounce in a few years). If these numbers seem absurd, consider what an investor from any month in the early 1980s would think upon getting a sneak preview of the financial section of today's newspaper!
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In summary, my current outlook is MODERATELY BULLISH. Because the investing public has been thoroughly enamored over the stock market rally, they have not generally considered alternative investments such as gold mining shares, but will have nowhere else to go once the stock market becomes obviously bearish. Strength in commodities causes weakness in bonds, leading to a slump in stocks and stimulating a surge in precious metals. Continued high volatility in the stock market will significantly accelerate and intensify this rally, as the historical record has demonstrated. I would recommend that investors establish long positions in undervalued shares so that the exact timing of the move is not as important as the amount of the increase, and to prevent being forced to sell out due to margin calls. Keep an eye on the JOC commodity index as a trend setter.
c 1996-1998 Steven Jon Kaplan Your comments are always welcome.
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