Leonard Kaplan
Prospector Asset Management
For markets of Tuesday, January 21, 2003
GENERAL COMMENTS:
As the events of the world continue to unfold, usually in a fearful manner, the gold market has rallied sharply these last two weeks to press against technical resistance at the $360 price level. The financial world, which seems to convincingly believe that a war in Iraq is inevitable, has bought the gold market, the oil market, and has pummeled the USD relentlessly. It is clear that everyone is standing on the same side of the rowboat, that we see markets that are clearly dominated by speculative fervor, that now have a very significant "war premium" built into current prices. We clearly have runaway bull markets in gold, oil, and the European currencies. Prices are currently well above fundamental supply/demand "value" and the markets are clearly anticipating perhaps not the worst case, but a very bad one. These are obviously dangerous markets to trade, more so than has been the case for many years. But, the trend in gold is most decidedly higher and more and more mainstream analysts are now touting the ownership of gold, having missed the first $100 move of the bull market.
Trust me, the market is now almost completely dominated by the investor or speculative concern and physical off take is simply awful. Lease rates for gold remain at virtually zero for the shorter-term durations and constructive reports of actual physical demand are virtually impossible to find. Investors and speculators are buying derivatives, or futures, while the actual metal remains unloved and unwanted. This should not be a great surprise, as "paper gold" is so much more cost efficient than the underlying precious metal. But, the downside risks of the gold market have been greatly enhanced not only due to the lack of physical demand at these lofty price levels but the fact that the current price of gold is maintained solely by the psychology of investors and speculators. And we know how quickly that can change.
I would still believe that we would see a retracement in the gold price from our current levels, providing a superb opportunity to get very long this market. Looking at historical data, please note that gold prices plummeted when the USA invaded Iraq and it was clear that the war would be quite short. So, IF there is a war, it becomes likely that gold will fall in price. And IF there isn't a war, it is clear that gold will lose some of its "war premium". Either way, we may go lower. But, there is another possibility and one that the market is screaming to all who listen, that we do go to war and it becomes ugly. These are difficult times to trade. All depends on the news, geopolitical events, and the psychology of the speculator.
I would guess that the best course of action is to own some gold at this juncture, just a bit. Either paid for in full or just slightly leveraged, knowing that you could suffer a loss if the geopolitical situation of the world improves. Or play the futures markets just a bit, using close stops on futures contracts or perhaps even buying bull call spreads. The trend is higher but there is certainly more risk in this market at this time than we have seen in years. While I sincerely detest buying options, perhaps buying bull call spreads in gold, at this time, makes quite a lot of sense at this time as it combines limited risk with excellent potential. Clients of the firm and readers of this commentary are welcome to call to discuss this strategy.
Silver continues to under perform the gold market as its industrial "nature" is now seemingly in charge. Silver, at around $4.80 per ounce, is the same price as when gold was scraping its most recent lows at $300. Gold has risen some 20% since then and silver has barely budged. The gold /silver ratio is now above 74 to 1 and certainly looks to go higher. I do see silver as somewhat undervalued at current price levels, but I would imagine that the upside is sorely limited unless this market begins to see some investor and speculative interest, something that is sorely missing. Silver has donned its "industrial metal" image and significantly higher prices will not be seen until it regains its crown as a "monetary metal", much like its much prettier sister, gold. Until silver can convincingly surpass technical resistance at $5.15 to $5.25, it remains a trading vehicle and is more related to the health of the economic recovery than to the demands of speculative interest.
Platinum and palladium have done very well of late, rallying quite sharply. While some bullish sympathy is, of course, seen with the advancing gold market, these markets are rallying for all the right reasons and their prices do not, in my opinion, carry a large "war premium". The rallies we have seen in these metals have occurred primarily due to fundamental considerations and look to be VERY advantageous for the more conservative investor/speculator at this time. I see the downside risk in these markets as much reduced in comparison to the gold market. Clients of the firm and traders who follow our recommendations are now showing excellent mark-to-the-market profits in these markets and I continue to look for much higher prices.
There has been much talk among traders and analysts of late about the correlation between the values of the shares of the gold producers and the price of gold. While gold remains a dollar or three below its 5-year highs, the gold stocks are still 30-50% off their highs seen earlier last year. It was once strongly believed that the gold stocks PREDICTED, or led, the price of gold, but this correlation is now very dubious. Could it be that the gold shares are telling us that this rally in gold is not to be believed? Doubtful, as gold continues to rally while they falter. What I believe is really happening is a realization of the fact that these two markets are not as positively correlated as many gold bugs would like to believe.
Central Bankers continue to sell gold into the market, thumbing their nose at the humiliating experience of the British Treasury who sold half of their gold reserves at an average of $275, now about $85 less than the current price. Canada, Netherlands, Portugal, and the Swiss sold gold into its rally in December. It seems that the $100 rally in gold only encourages the Central Banks to continue selling their gold reserves even though it is the best performing asset on their books. They are selling their winners, and holding onto their losers such as the USD and equities. This makes very little sense in the current geopolitical environment and speaks volumes about the market "savvy" of these purported professionals. I am frankly amazed that there has been no public outcry from the citizenry of these nations due to the actions of their Central Banks, especially the British.
It would appear that the Central Banks will certainly continue to be sellers into this bull market in gold and that there are few Central Banks willing to add to reserves. Oh yes, China and Russia are adding gold to their reserves but, MOST IMPORTANTLY, they are NOT buying gold in the open market, using hard currencies, but only buying internally produced gold for their native currency. Look, if you were a Central bank, and had the chance to add gold to your reserves for paper money that you could print at will, you would, of course, do it. This is the case with both Russia and China. They are not entering the global market and spending Dollars, they are buying internally produced gold for their local currency, while other Central Banks are selling gold for USD on the open market. It is strictly a one-way street. I would expect continued selling by the Central Banks, perhaps even accelerated as time goes by, and these sales depend upon the willingness of the speculative crowd to buy. However, history teaches us that the Central Banks, who should the sharpest in their knowledge of the markets and of the economy, tend to be sellers at the bottom and buyers at the top. Perhaps they are just leaning against the wind.
Platinum and palladium will most likely go higher next week as the workers at Norilsk, the Siberian concern which produces some 70% of the worlds palladium and about 20% of the global production of platinum are now threatening a strike unless their demands for pay raises and longer vacations are met by management. The union is asking for a raise to a monthly salary of $853 per month, about a 20% raise from current levels.
Gold producers continue to be the MAJOR buyers of gold in this market, far outshadowing the demands of the speculative crowd for physical metal. As per Virtual Metals and Haliburton Mineral Services (sponsored by Rothschild), the international global hedge book, representing some 65% of global production, continued to shrink in the 3rd quarter of 2002 to 2692 tons, falling by some 15 tons. Still, all in all, about 2700 tons, counting just 65% of the total, remain either to be bought in the market to offset gold previously sold forward, or delivered into the market. If mathematically computed to about 3600 tons, this comprises just less than 2 years of total global production of gold, still a really hefty amount. AND, given the fact that stockholders of gold producers now consider ANY hedge to be complete anathema, it would appear that the demand for gold from this sector would continue to be evident. Andy Smith, who has been the most accurate, as well as the most controversial, gold analyst in the business notes that hedge book reductions by just four of the largest gold producers contributed 4.9 Billion USD of gold demand, while purchases of gold eagles, inflows into USA mutual funds that invest in mining concerns and Comex speculators total only $730 Million USD. It is most important to know exactly where the demand is coming from, and it is not the physical marketplace, it is not India or China or Japan, it is from the very gold producers who should, naturally, be sellers of gold who are now forced to be buyers. It certainly is a most strange world.
On to the Commitment of Traders Reports, as of January 14th, for both futures and options:
Gold
Long
Speculative Short
Speculative Long
Commercial Short
Commercial
94,090 28,889 77,934 190,643
+347 +1,341 -428 -3,389
Long Small Spec Short Small Spec . .
78,102 30,595 . .
-884 +1,082 . .
While the ownership of gold futures contracts on the exchange barely budged last week, it is most evident that everyone is standing on the same side of the boat, that the speculative crowd is very long at present. Spec longs have commitments for 17.2 million ounces of gold vs. the speculative shorts with 5.9 million ounces. If, and that is a very big IF, we begin to see a change in investor psychology that forces some long liquidation, we will see a very sharp decline due to the fact that physical demand is nonexistent at these price levels. But, if the news and geopolitical events worsen, gold will go higher. So far, the longs in this market have demonstrated that they will not be shaken out of this easily and their resolve seems quite sturdy. All said earlier, all depends on the news.
It is also worthwhile considering how the internal structure of this market has changed over the past several months. Please understand that no one with an IQ higher his shoe size wants to be short the gold market. Just a little bit of buying of gold pushes it higher than it would, let's say, 6 months ago. This makes for a dangerous scenario IF the longs ever want to get out; there are not natural shorts to sell to. The entire structure has changed.
Silver
Long
Speculative Short
Speculative Long
Commercial Short
Commercial
46,529 8,321 19,924 87,650
-130 +1,457 +2,569 +1,623
Long Small Spec Short Small Spec . .
36,406 6,888 . .
+379 -262 . .
As in gold, there was little change in the ownership of contracts on the exchange during the reporting week. Speculative longs are long 414 Million ounces vs. the speculative shorts at only 76 million ounces. This ratio, at 5.5 to 1 bespeaks the mood of the market as totally one sided. But, silver has not performed well recently and I wonder how much longer the resolve of the long speculators will hold. Clients of the firm and traders who follow our recommendations, are delta neutral in this market and I will wait for lower prices to re-enter.
Platinum
Long
Speculative Short
Speculative Long
Commercial Short
Commercial
5,739 1,275 806 6,716
+632 +3 -506 +178
From the above numbers, it is shocking clear that the large speculative concerns have grabbed hold of this market. The platinum market is very thin, and the funds, with Billions of USD in their coffers, can move prices easily. My sense is that prices are going much higher. Platinum has better fundamentals at this point in time than either gold or silver and I would think that long positions could entail less risk. I also highly recommend palladium for some accounts. Please consult our offices for specific recommendations.
GOLD RECOMMENDATIONS:
Expected trading range $345.00 to $358.00
Good technical support exists around the $349-$350 price level with superb support in the low $340's. The $357-$358 price level has, so far, successfully thwarted all rallies and should be seen as VERY SIGNIFICANT resistance. Day traders should pick their points carefully and use rather tight stops. Staying on the long side makes a whole lot more sense. All movement within this range is almost inconsequential and trades should only be taken against or through these numbers. Expect greatly enhanced volatility and watch the foreign markets carefully. And, of course, the news will make the market. These are dangerous times for day traders especially if you take the short side.
For position traders, the times are difficult to judge. I would like to start buying gold in the $342 range, building a position all the way down to $328, but that may never happen. Lets buy at the numbers listed above, OR buy a bit on a close over $360 using a $4 stop. If gold drops a bit, aggressively sell out of the money puts at $325 or $330 to replace the positions lost to the options we sold. And, now is the time to buy some insurance, buy some bull call spreads, but only in smallish quantities as buying options is rarely a good idea.
SILVER RECOMMENDATIONS:
Expected trading range $4.74 to $4.85
Day traders should be playing the range here. Short positions in silver are a lot less dangerous than short positions in gold it would seem, so when you want to be long, buy gold, and when you want to be short, do it in silver.
Position traders, and traders who follow our recommendations, are now delta neutral on silver, waiting to reestablish long positions at lower prices. On dips, sell out of the money puts.
PLATINUM RECOMMENDATIONS:
Expected trading range $610 to $640
Clients of the firm, and traders who follow our recommendations, are still long both platinum and palladium with superb mark to the market profits. I would be buying more as both markets move into new highs, but only a bit. Platinum looks to want to move to the $640 to $650 range and partial profits should be taken at those price levels. I am long term bullish on palladium and continue to recommend adding, carefully, to positions for a long-term move.
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