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Market Commentary

For markets of November 24th

CLOSES INDICATIVE LEASE RATES Based upon 30 day maturities
DEC GOLD 396.00 GOLD .00/.50%
DEC SILVER 5.295 SILVER .50/2.00%
JAN PLATINUM 760.30 PLAT 2.00/7.00%

General Comments:

Even as the USD fell by 1% last week, such positive encouragements were still stubbornly snubbed by the precious metals, as they fell in price week-on-week. With many old-time gold bugs cheerleading the price on its onslaught through the "magic" number of $400 per ounce, gold prices were lower by $2.00. December Gold traded above $397 on each day of last week, but was unable to convincingly pierce the $400 price level. As we will see later in the Commitment of Trader's report, the large speculators and funds did indeed try very, very hard to push prices higher, to no avail. Enough selling emerged, from the commercial shorts, to effectively prevent higher prices.

There has been a great deal of misinformation in the financial press which has intimated that gold is being restrained in price due to the very large option expiration of the December gold contract, come next Monday, and the huge amount of $400 calls outstanding. My goal is not to judge the veracity of such speculations, but to explain how the market works, and why. Many rather dogmatic gold analysts write that the "big boys" are holding down the price to profit from options expiring worthless for many investors, most of whom are relative newcomers to this financial arena, or can also be considered to be poorly capitalized. This supposition inherently assumes that these "big boys" are not hedgers, are not market-makers or dealers, but are "cowboy" speculators willing to assume absolutely huge positions and huge risk to accomplish their goals.

While such large traders can and do exist, MOST (to an overwhelming percentage) of the call options have been sold by dealers, who do indeed HEDGE their positions. Such dealers "delta hedge" their position, buying or selling futures as prices move to maintain a neutral position. I will spare you the mathematics, but dealers or traders, who are short the market by selling $400 calls, are forced to buy more futures as the prices rises, and sell more when the price falls. Dealers or traders who are long the calls hedge their positions by selling as prices rise and buying as prices fall, the opposite of those who are short. As we get closer to option expiration, such trading usually takes on greater sensitivity, as the time value of the option contract deteriorates. And, quite logically, as there is a buyer for every seller, prices tend to get " pinned" to a specific number, usually quite close to a "round number", where neither the buyers and sellers of the options have to act to properly hedge their exposure to the market. Just as water finds its level in a glass, the market finds its equilibrium price. Long-time watchers of the commodities markets have seen this over and over again, and very few would deny this proclivity.

Due to the very internal nature of the transactions being forced upon the dealers, another characteristic of commodities going into option expiration is that prices tend to be choppy, moving up and down although within a very narrow band. As an example, December gold traded at least as low as $392.70 every day last week and traded as high as at least $397.50 on every single day last week.

To the untrained eye, when prices settle almost exactly on a large round number, making all the puts and calls worthless, or virtually so, to the buyers, some analysts (especially those fixated on proving some international conspiracy) would have you believe that the "big boys" fixed the market. They would have you believe that it is proof positive of manipulation. The truth is much different. It is a natural phenomenon of the market to behave in exactly this manner, as the dealers and market makers delta hedge their positions.

While hedging of risk by dealers and market-makers comprise almost all of the activity, there is left the thought that some entities are NOT hedged, that some firms, or traders, are taking huge risks in the market to assure the stability of prices going into option expiration. I will let each reader decide for himself the extent of such goings-on. All that I will state is while such activities do indeed exist; it is my experience that they are only a tiny fraction of what many "urban legends" would have you believe.

The tendencies of the market, as noted above, have enormous pragmatic use. They teach us that, all things given equal, that it is better to be a seller of an option, rather than the buyer, as the market will attempt (but certainly not always succeed) to make that option expire worthless. And, those prices may move in a rather volatile but almost predictable pattern in the days approaching option expiration.

In rereading the paragraphs above, I am taken by the literary privileges I have taken, and some gaping holes in the flow of logic and reason. This is a most complicated matter, and not suitable for a page and a half. This commentary is not just about the precious metals markets, it also attempts to explain HOW these markets work.

Silver prices were down by 12 cents for the week, as price movements shadowed gold to a large extent. As expected, this market again experienced huge volatility, when on Monday December Silver traded as high as $5.43 only to collapse in a matter of hours to a low of $5.14. By the way, if you had placed buy orders at $5.25 ½, and sell orders at $5.32, you would have bought and sold this market each and every day. Again, coming into option expiration, we see high volatility within what was mostly a narrow trading range.

Platinum and palladium were also lower on the week, the former down by $10 even though rather bullish news emerged, while palladium was lower by $7. The eagerly awaited interim review of these markets by Johnson Matthey suggested that global platinum demand will rise by less than ½ of 1% for 2002, while supply will increase by 2%, narrowing the ongoing fundamental deficit from 590,000 ounces per annum to 480,000. While sales to automobile manufactures have been booming, sales of platinum into China for jewelry have been waning. Johnson Matthey also, most correctly, mentioned that much of the rise of the platinum price this year has been due to speculative fund buying. They also foresaw continuing softness in the palladium price as supply continues to outstrip demand.

Please remember that a previous commentary, studying the long-term relationship between platinum and palladium, found that palladium averages 40-50% of the price of platinum. And now, with platinum some 4 times the palladium price, it appears that this relationship is much askew. I continue to be bearish on platinum, and will continue to look for every opportunity to sell it. While the fundamentals still call for higher prices, I put a bit more faith that when the large speculative funds get a bit itchy to liquidate their positions, that they will find few willing buyers at these price levels. As Tom Kendall wrote in the report, "Fund activity is likely to continue to have a major, if unpredictable, influence on the platinum price in the short term".

The gold market last week was rocked a bit, and even more confused, by comments from Peter Munk of Barrick Gold, one of the largest gold producers of the world, and owners of a hedge book of 16.1 Million ounces of gold already sold forward into the markets. It was first reported that this gentleman told an investment seminar that hedging through forward sales was "essential", and that (to quote), "it is our fundamental responsibility to run the business as a healthy business". OK, then just hours later, in speaking to the press, Mr. Munk dropped the bombshell that Barrick is "no longer committed" to forward selling gold for the 10 years. But, this gentleman did not comment on whether or not this firm has committed to lowering its large hedge book. Since this firm has rather unique derivative forward positions that allow it to sell its gold on the open market at the time, rather than deliver into previously sold forward positions, the gold market doesn't quite know what to make of the comments.

As you might expect, physical demand of gold into India, the largest and most important buyer, has shriveled due to currently high price levels. Reuters reported on the 17th that imports of gold into Ahmedabad had fallen to 50-60 Kg per day from 300-400 per day. Rather than buying "fresh" gold, price conscious Indians are simply recycling old jewelry into new. There is no surprise that the physical market is not healthy here, as this condition has been going on for quite some time. The gold market continues to be driven by speculative and investment demand rather than moved by the immutable forces of supply and demand.

On November 19th, the Bank of China opened gold trading services to individuals. Individuals may now trade gold at any of the 95 branches of this bank, or trade on-line. Other banks are hurrying their plans to also offer these services. There exists a great hope in the markets that the Chinese public will embrace this market. It will be important to wait and see what happens here.

One comment regarding silver and then on to the Commitment of Traders reports. Silver warehouse stocks at the Comex have risen sharply over the last two months, now approaching 120 million ounces, even as the price has risen. This bears evidence that the rally we are seeing in this market is "paper" driven, not physically oriented. It can not be a good sign that physical stocks are rising even as prices rise.

Long Speculative Short Speculative Long Commercial Short Commercial Small Long Spec Small Short Spec
143,000 16,627 138,232 314,295 82,073 32,383
+13,858 +580 +3,475 +18,875 +9,902 +7,780

During the reporting period (11/11/03 through 11/18/03), gold was up well over $9 as long specs added hugely to their positions, almost 24,000 contracts, or 24 Million Ounces. Long specs are now 4.6 times the number of their counterparts, the short specs. As noted earlier, the major sellers were the short commercials. However, interestingly enough, we also see a rather steep increase in the position of the small shorts in this market. Open interest was up over 36,000 contracts, a positive sign.

Overall, I have a convoluted opinion in this market as to what will occur. While I believe that prices are still headed higher, I do not foresee a "runaway" if and when gold finally breaches the $400 price level. If we go higher, it will be grinding away, with significant volatility. But, owing to the nature of the internals in this market, if we go lower, there exists a very decent probability that we could see a very vicious and sharp sell off. The risks are now tilted to the downside in this market, as rallies will be arduous while declines have the chance of being quite vicious if the long specs all decide to "cash in" at the same time. As such, it is best to lighten up long positions at these levels, by either selling futures or continuing to sell nearby out of the money calls. Call our offices for specific recommendations for your account.

Long Speculative Short Speculative Long Commercial Short Commercial Small Long Spec Small Short Spec
47,453 2,596 25,535 97,770 40,600 13,221
+14,570 -1,126 +1,722 +16,686 +2,485 +3,217

During the reporting week, prices were up some 30 cents on what was obviously a speculative frenzy by the large long speculative funds. Their purchases were accommodated by the short commercials in full. The speculative market is now very heavily tilted, with long specs some 5.5 times the short specs. As in gold, the risks are now to the downside; upside progress will be hard won. With call options paying a fortune, I would recommend a rather aggressive selling of calls on all futures positions held. Recommendations to follow.

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

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