Kaplan
truecontrarian.com
INTERMEDIATE-TERM FINANCIAL OUTLOOK: The main focus in the U.S. financial markets remains the U.S. dollar, but first let us consider recent important developments, especially with commodities. The traders' commitments for both gold and silver deteriorated sharply in the past week. Gold commercials added 32,104 to their net short position, and became net short 154,266 contracts as of Tuesday's close. Since gold has risen an additional $4.50 since Tuesday, it is likely that commercials are currently net short more than 160 thousand contracts. This is higher than almost all historic readings in the past three decades, including those in January and February, but are not as high as the record commercial net short position in early April of almost 200 thousand, which preceded a 14% fall in gold, and a 30% drop in most gold mining share prices over the subsequent six weeks. Thus, momentum might carry precious metals higher in the very short run, but a significant downside move in both gold and in gold mining shares is likely very close timewise. Technical chart divergences are already turning increasingly negative, such as in Friday's trading when gold peaked just after the open, and gold mining shares closed at their lows of the day in a progressive afternoon fade, with HUI not quite reaching an important intraday multiple of 10 (239.90), and closing just below a multiple of 2.5 (at 237.44). For silver, commercials added 15,845 to their net short position, and were therefore net short 67,291 contracts as of Tuesday's close. As with gold, the current net short position is likely greater, given silver's move to new highs later in the week. This is not as exaggerated as it was in early April, but then again, after April's extreme net short position, silver collapsed by three dollars, more than 35%, in just six weeks. The Commodity Research Bureau's index of commodities also surged to a multi-year high in Friday's trading.
What is currently happening with commodities is typical of a bull market in any financial asset. Given an improvement in underlying fundamentals, a strongly undervalued asset becomes less undervalued as savvy bottom-fishers purchase this asset near an important cyclical low. As time passes and the chart patters for this asset look more positive, combined with short covering by speculators who were previously confident of a continued price decline, the price of this asset rises first to fair value and then higher. As the rally continues and becomes more noticeable by average investors, a large contingent of buyers who are trading purely for momentum pushes this asset into a level of clear overvaluation. Initially, this serves to push prices even higher, as media coverage becomes almost unanimously positive and a new crop of long-side promoters encourage the least informed segment of the investing public to become involved. This stage has finally been reached in the commodities markets in general, as those advisors and media which had been almost universally bearish on commodities just three years ago are now almost unanimously bullish. Speculation has driven commodities prices to the levels at which those most closely connected with the industry, who have been progressively selling short in recent weeks, are now in a position to benefit handsomely by engineering a sharp, short-term price collapse, just as they did exactly six months ago. Since the futures markets were created for the benefit of the commercials, Comex commercials can simply ask the exchange to raise the margin requirements for speculators. Such an action would force speculators to raise their sell stops for tens of thousands of contracts much closer to current prices, and therefore a mild price drop could easily be exaggerated by a cascade of stop-loss selling to create a short-term collapse. This most recently happened in a six-week period from April to May of this year, as described above, and conditions are almost as ripe for a repeat performance. One indication that a pullback is imminent are the number of covers of financial publications in the past two weeks that excitedly tout either commodities themselves or the shares of commodity-producing companies. Media coverage toward commodities at this time is even more positive than it was in early April, raising the danger that recent very heavy fund flows into commodity and commodity share mutual funds have been swelled by the ranks of latecomers who have no emotional or knowledgeable commitment to the sector, and are buying only because "everyone says its going up, and I don't want to miss out". These investors are notorious for bailing out when faced with even a modest price decline, and are therefore likely to exacerbate any downside move by their inevitable selling when things turn sour.
I am always skeptical of accusations of collusion or manipulation of the financial markets, but it must be considered that President Bush would not like voters to go to the polls at a time when crude oil prices are at an all-time high, and the U.S. dollar is in a freefall. Therefore, whether it means selling crude oil from the national reserves, or talking up the greenback, or whatever other actions the President can take overtly or covertly, they are likely to be engineered before the election on November 2, rather than after. There is also a historic seasonality pattern in which precious metals present an excellent buying opportunity shortly before the American Thanksgiving holiday, which occurs this year on November 25. That is partly because gold is a popular Christmas present, and therefore frontrunners usually get the edge ahead of these buyers. The period of heaviest overseas buying of gold is also about to pass, with most important lunar holidays having occurred a couple of weeks earlier this year (relative to the solar calendar) than in most years, and which have been generally winding down around the world. Worldwide physical buying of gold is at its lowest point since early April, and remains at significantly lower levels than in 1998-2003, as price-sensitive buyers are reluctant to pay for precious metals near their 17-year highs. The lifting of hedges by gold producers has picked up most of the slack, but historically when physical buying has been poor, subsequent price action has been to the downside.
As pointed out in the past two updates, the U.S. dollar has been making a very impressive series of higher lows since February. The July low is substantially above the February low, with the September low slightly above the July low, and the October low slightly above the September low. In the past three weeks, there have been repeated intraday attempts to push down the U.S. dollar in the morning, with the greenback fighting its way back in the afternoon. When this pattern is seen in any financial asset over an extended period of time, it generally precedes an extended rally, and a move higher is therefore what the U.S. dollar is likely to enjoy over the next several weeks, if not longer. Media coverage remains lopsidedly negative toward the greenback, while the dollar's modest rebound in the past seven months has received basically zero attention or comment. Very negative sentiment accompanied by rising prices is almost always a very positive sign for future gains. Interestingly, exactly the opposite situation can be seen for U.S. equities: a clear pattern of lower highs accompanied by rising optimism, with bulls outnumbering bears 2:1 in most surveys, and rising complacency as evidenced by multi-year lows in most index volatility measures. Thus, expect U.S. equities to decline while the U.S. dollar rises in value. There remain few speculators on the short side for most currencies. The U.S. dollar may therefore be signaling an upcoming upside breakout. As the dollar rises, gold and silver prices are likely to decline. Bullish sentiment toward gold is above 80% for the first time since early April, and is at a level which has marked numerous previous price peaks. |
