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Market Commentary

For markets of October 27th

Based upon 30 day maturities
DEC GOLD 389.20 GOLD .00/.50%
DEC SILVER 5.165 SILVER .50/2.00%
JAN PLATINUM 737.60 PLAT 6.00/11.00%

General Comments:

The precious metals markets were, again, afire last week as speculative forces renewed their interests. Prompting their purchases was the continued decline of the USD (down about 1% on the week and making new lows) and the newly found concerns about the equities markets (down almost 1% for the week). These markets continue to be largely speculative affairs, with prices almost solely dictated, as they have been for months on end, by the coming and going of speculative and investment activities. Gold prices were up almost $17 for the week, just several dollars short of a new 7year record, although a new record high close was recorded for the December Comex contract. The silver market shadowed gold almost precisely (both up a bit under 5% for the week), rocketing up 22 cents even though weakness was seen in other industrial metals, such as copper. As noted in this commentary on many occasions, the silver market is usually quite difficult to trade or to forecast as it is buffeted (no pun intended) by the external stimuli of both the industrial metals, and of its intermittent kinship with its sister, gold, as a monetary instrument.

Platinum prices were up almost $13 for the week, reaching new 23 year highs, but closing some $9 off its highs reached in mid-week. Palladium prices, still plowing the well-worn trading range of $190 to perhaps $220, were higher by $2.

While the secular bull markets in gold, silver, and platinum continue unabated, volatilities and commensurate risks in trading have exploded. This fact is most clearly demonstrated by the market movements on October 3rd, when gold prices fell by $20 at their lows of the day from the previous day's highs, only to recover ALL of the losses by October 22nd. Silver lost some 32 cents on that day, only to see prices climb back. The predominant reason for such lunatic and erratic price changes is that not only are these markets completely dominated by speculative activities, but these traders generally have "stop-loss" orders in place against their positions. As these resting orders are executed on the floor of the exchange, it often begets a cascade of selling, with each sell order pushing the market into further stop orders, a self perpetuating downward surge. Now, please understand that almost every professional in the industry knows precisely where these "stops" are, and that it can be enormously profitable to run the price into these orders.

As an example, let us display how the game works, and why it is so profitable for large, and nimble, traders to raid the deck (the stack of resting stop-loss orders). Let us suppose it is widely known that there are oodles of sell-stops located just under the $380 price level. So, let us suppose that an extremely well financed, and respected trade house begins selling at the current market price, let us imagine it as $382. As the price is forced lower into the sell stops resting in the market, the speculators begin selling their long positions, and the trade house, having gone short at $382, now buys from the hapless speculators, pocketing a quick $2-$4 per ounce. This strategy, of course, works on the upside as well. As long as there remains significant stop loss orders AT ANY PRICE level, it is extremely profitable for the adroit and well financed firms to move the price to execute these orders. It is not a matter of manipulation; it is just how the game is played.

While gold prices continue to ramp higher due to speculative fervor, there are increasing signs that demand in the physical market is lagging, and lagging badly. There are reports from India that gold purchases for Diwali are sagging badly, perhaps down 50% off of last year's demand, due to the high price of gold. Indians tend to be "value buyers", and it is apparent that they see little value at current price levels. Reports from the jewelry industry in the West, the USA and Europe, also are rather ominous. While such bearish news for gold emerges, it must also be stated that this has been the case for some time now, months and months at the very least, and yet, gold prices have continued to rise to test 7 year highs. This simply demonstrates that, now, the gold market price is being set not by the commercial and industrial faction, nor by the gold producers, but by the judgments and decisions of the speculator and investor. This is not good nor bad, it just is. When analyzing any market, it becomes imperative to understand just what is important, and what is immaterial. While many analysts decry the current market condition, forecasting sharp drops in gold prices because of a lack of actual physical demand globally, the truth is that it doesn't matter, at this point in time. What does matter is the psyche of the speculator/investor. As long as the USD continues its decline, as long as the stock markets no longer lure as before, as long the macroeconomic forecasts remain gloomy, as long as the political scene continues to frighten, gold will remain firm. It has not been rising on an increase in demand from industrial users or jewelry buyers; it is rising due to its fundamentals on an economic basis, as a "safe haven", as a comfort for those seeking shelter from the economic and political storms. Yes, we will see vicious retracements in price from time to time, but gold is now up some 55% from its lows seen just 4 years ago, and looks to move higher.

Speaking of horrible fundamentals, gold demand in Japan has just plummeted. Many years ago, this country held the hope for many gold bulls as it was thought that with their monstrous asset pools, and with the difficulties with their banking system and their economy, that the public would rush into gold. In fact, one year the World Gold Council made the decision to spend MOST of their resources in the promotion of gold as an investment in Japan. Well, In August of 2003, the entire nation of Japan imported a grand total of about 2.6 tons of gold, down 50% from that of last year. To put that into perspective, only about $32.5 Million Dollars of gold was imported into that nation.

It is obvious that very few are buying physical gold. As an example, the only listed security that represents physical gold ownership, without any leverage or margin, is Gold Bullion, currently listed in Australia, although there are plans to "roll out" such exchange traded funds, or perhaps similar securities, in other countries. This fund has been operative for many months now, has attracted the interest of international interests, and yet, has currently only 6.5 tons of gold on its books. The performance has been quite poor, as I expected. And yet, open interest and volume on the global commodity exchanges, where the sophisticated investor and speculator come to "play", usually heavily margined, continues to set new all time records. Quite obviously, right at this point in time, physical demand does not matter, as prices continue to rise in the face of deteriorating demand.

It is now almost universally accepted that the Central Banks of Europe will resign another Washington Accord, where their sales of gold and uses of leasing and derivatives were fixed in 1999, sometime next year. While such an extension of this agreement would obviously be bullish as it would remove the fear of profligate sales by these banks, it is as yet unsure just how much gold per annum would be allowed to be sold. In the old agreement, it was restricted to 400 tons per annum. Current guesses are that the new agreement will allow increased sales, somewhere in the range of 450-550 tons per annum. We will know more perhaps in the middle of next year, but so far, it all looks rather promising. I would imagine that it would be rather difficult for the Central Bankers of Europe to sharply up their disposal of gold as a reserve in the coming years. Please note that the Central Banks of Britain, and Switzerland, among others, were big sellers these past few years and that they look like total morons now that gold is at 7 year highs.

The Shanghai Gold Exchange continues to liberalize its rules in gold trading, at a rather aggressive rate. While all gold trading has been "cash", where money and commodity change hands immediately, now the exchange is allowing a 5 day window for the settlement of a transaction. This is obviously the precursor to futures trading as we know it in this country. The rate of advancement and progress has been quite quick by that exchange. The general public, and foreigners, are still prohibited from doing any business, but that may change if the rate of liberalization continues.

The platinum market has rallied over $50 per ounce over the past few month, as the realization hit the market that the massive expansions in production, planned by the South African mining giants, would NOT take place, as a strong local currency, increasingly onerous governmental regulation, and a dissident National Mining Union all take their places to assure that these formerly proposed expansions would turn out to be inefficient and unprofitable. Years ago, when the plans of the South African producers were announced, they were thought by many analysts to be on the far side of grandiose, and they have turned out to be just pipe dreams to a great extent. It is thought that Angloplat, the world's largest producer, will produce 2.9 million ounces by 2006, down sharply from earlier estimates of 3.5 million ounces. Yes, we will see some expansions in production, but not at the rates previously announced. And, this has emboldened many investors and speculators to push this market to 23 year highs.

There was also news emerging from Russia that this nation may disclose stocks of platinum group metals held by the Central Bank and the State Depository. But, please contain your excitement as such changes will take two to three years. And, knowing the Russians, they would never consider releasing such information if it were not very advantageous to their own benefit. So, stockpiles of platinum and palladium will remain state secrets for what I guess to be a long time.

On to the Commitment of Traders reports, as of 10/21/03, both futures and options:

Long Speculative Short Speculative Long Commercial Short Commercial Small Long Spec Small Short Spec
120,024 12,711 125,815 178,988 68,810 22,950
+7,539 -112 -1,257 +9,300 +3,770 +864

During the reporting period, where gold was up almost $6, and open interest rose by over 15,000 contracts, long speculators, both large and small were the only buyers, to no surprise. Commercials were on the other side of the trade, as their inventories and long commitments swelled due to the lack of physical offtake. With long specs now 5.3 times the short specs, further rallies in this market become highly suspect, especially as we approach the "magic" number of $400 per ounce. I sense it is going to be very arduous for us to climb past $400 without any major decline in the USD or an outright collapse in the equities markets. I would imagine that we will see rather aggressive liquidation of long positions on almost any sort of rally. While the upside seems very limited, I do not foresee any sort of major retracement in prices, as this market is heavily supported by external stimuli. My best bet is that we see some manner of consolidation, with prices bouncing from perhaps $378 on the downside to perhaps just over $390 on the upside. With volatilities quite high, this is an excellent opportunity to sell out of the money puts and calls.

Long Speculative Short Speculative Long Commercial Short Commercial Small Long Spec Small Short Spec
32,949 6,493 24,775 79,174 38,017 10,074
+1,561 -1,701 +2,315 +5,306 -397 -127

Silver prices were up some 13 cents during the relevant period, with open interest climbing by almost 7000 contracts, a rather classical bullish signal. Long specs are 4.2 times the short specs, not quite as dangerous ratio as we see in gold. Another bullish signal is that long commercials added 10% to their positions, at price levels where historically they have been most reluctant to take on positions. In comparison with gold, trading levels are still rather muted.

Although this market has better "internals" than gold, I would imagine that silver prices will continue to shadow the gold market, and a period of consolidation is the most likely outcome during the coming week. Look for prices to trade between $5.05 and $5.20. Again, make full use of selling both out of the money puts and calls for your account. Due to the complexity of these options, and the risks involved, it is most difficult to arrive at a universal recommendation. Please call our offices for specific advice.

Long Speculative Short Speculative Long Commercial Short Commercial
5,723 545 384 6,799
+259 +131 -217 -200

Just looking at the composition of the ownership of futures in the statistics above, has to scare the pants off of the longs in this market. This market is clearly a battle between the large long specs and the commercials, and it is likely that the speculators will flinch first. This market has had a long run, and just perhaps, it is time for a bit of a turn back. Recommendations will follow.

(positions and recommendations are available to clients and subscribers only)

Expected trading range $5.05 to $5.28
(positions and recommendations are available to clients and subscribers only)

Expected trading range $720 to $745
(positions and recommendations are available to clients and subscribers only)

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