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Market Commentary

For markets of December 8th

CLOSES INDICATIVE LEASE RATES Based upon 30 day maturities
DEC GOLD 407.30 GOLD .00/.50%
MARCH SILVER 5.492 SILVER .50/2.00%
JAN PLATINUM 790.70 PLAT 2.00/7.00%

General Comments:

As the USD spins ever lower in its continuing death spiral, the gold and silver markets were the perfect partner, matching each step in almost perfect unison. As the USD Index pushed below the psychological support of 90, gold prices pressed northward of the important psychological price of $400 per ounce, for the first time in 7 years. Prices were up $9.50 for the week, and most surprisingly, excellent buying was seen in the market on any dip, a most impressive performance. The gold market is seeing improving fundamental physical demand, much improved financial press coverage (mostly favorable), and seems to be moving from the hinterlands of the investment universe to an almost, but not quite, respectable choice for the global investor concerned with either adverse currency movements or just looking to plunge into what is certainly a long-term secular bull market.

Gold Fields Mineral Services, probably the most respected and most followed fundamental analyst, reported that total demand for gold rose by 5% in the third quarter of 2003. Jewelry fabrication rose by 5%, and implied net investment in gold jumped from only 2 tons in the third quarter of 2002 to 185 tons in the comparable period of 2003. Producer de-hedging, their repurchase of previously sold forward sales, reversed in this quarter and actually contributed to supply, albeit very lightly, for the first time in 7 seven consecutive quarters. Official sales were marginally higher, with mining output declining by .2%.

In reading the statistics above, I am struck by numerous implications for the gold market. The first being that FINALLY, after gold has run up some 60% off its lows, this market is now seeing material interest from the global investor. The political tragedies of the past years were not enough, the continuing macroeconomic maelstrom was insufficient, but finally, investors seem to be entering the market, although late to the party. Should this investment demand continue unabated, some 740 tons of gold per annum would be demanded, about 1/3 of total global production.

Over the past two years, the largest buyers of gold have been the very firms who produce it, a most ironic situation. Their purchases have far outweighed investor interest and have been instrumental in the continuation of the long-term secular bull trend in gold. Many analysts had grave concerns that when the largest buyers of gold (the producers) retreated from their aggressive shopping spree, that prices could suffer. Now we have clear evidence that the baton has been passed from the producers to the investors, in a most smooth transition. And, even better than that, the new breed of gold investor/speculator, as seen in the Commitment of Trader's reports and by monitoring the recent markets, seems to have significant "staying power", unlike days of yore.

Next, the gold market is now MOST CERTAINLY acting not as a commodity, but as either a currency or an investment vehicle, as you choose. As gold prices have almost precisely mirrored, in a negative correlation, the value of the USD, it could easily now be termed a currency. And, please note that demand for gold is now rising, even as prices have risen dramatically. This is in direct opposition to basic economic theory that rising prices ration demand. Now we have demand continuing to accelerate even as prices rally, a most bullish internal market condition that screams that the gold market could indeed go very much higher, as momentum begets greater participation from market participants.

While I remain steadfast about the long-term bull prospects for gold, I am becoming a bit concerned about the very short-term. My apprehension stems from the time of the year, to the technical studies of chart patterns, and a basic gut feeling that, perhaps, dangers are mounting to the view that prices will simply explode skyward. In the ten year chart depicted below, gold has rallied some 60% from its low in 1999, to make 7 year highs. Prices have moved relentlessly higher, with only once major setback. We are now attacking very significant technical resistance, although from a bullish perspective, the "rounded bottom" technical formation seen in this chart is perhaps the strongest bull formation. My sense is that perhaps a respite is needed in this market, that perhaps a price consolidation is required before we move higher. While I do not foresee gold prices skyrocketing at this point in time, I also do not envision that the downside has too much room.

Another reason to believe that the pace of gold's rise may slow is evidenced by the chart below, depicting the rise and fall of the USD over the past 10 years. As changes in the gold price have been virtually precisely determined by currency changes, the prospects for the USD are paramount. As the USD has fallen some 25% from its peak in 2001, the chart shows that we are now approaching considerable technical congestion levels, and that it will most probably take a bit of time for this market to move lower.

And, while the technical studies now indicate that perhaps gold is a bit overbought, they are sometimes wrong. But, there also remains a nagging fear that the large commodity funds, who now hold some 142,000 contracts (14.2 Million ounces or about 440 tons), will simply decide that they have had a very good year, and decide to sell to "lock in" their most respectable profits. I have seen such actions before as the year comes to an end. End of the year profit (or loss) taking occurs in all markets, and oftentimes the last weeks of December can be quite "weird" and unpredictable. To this end, as uncertainties have risen and chart patterns ask for caution, I have taken off the mantle of a steadfast bull, and have retreated to a neutral to slightly positive posture, but only for a few weeks. I don't know why but I just feel that the next $20 higher in gold is going to be a most difficult battle. This opinion is made from the comfort of my home on a Sunday morning, and market movements in the next few weeks could alter my convictions, oftentimes quickly. Clients of the firm, and newsletter subscribers, are welcome our offices for updates.

In the rush to bring greater accessibility to global investors, the World Gold Council will be enabling the launch of a Exchange Traded Fund in London on December 9th, allowing investors without commodity market knowledge or experience, to indirectly buy physical gold. This ETF is much the same as another fund launched months ago in Australia. This fund will be traded in USD, not in British Pounds, and will represent the first real test of the high expectations held for such an investment vehicle. Already, the Merrill Lynch Gold and General Fund has announced that it plans to purchase a significant amount of this fund when available, although the exact quantities were not made public. Please note that the Australian version has only garnered the paltry amount of 250,000 ounces on its books so far. For those with greater interest, go to www.goldbullion.com.

On December 3rd, the Chicago Mercantile Exchange commenced trading in gold TRAKRS, which as a very non-traditional futures contract, appears at first to be a derivative on a derivative sponsored by Merrill Lynch. This index is designed to track the price of gold, plus lease revenue, for a specified period of time. It is NOT marginable for the average investor, and costs appear both rather high and difficult to quantify. As such, over the longer-term, I do not see it truly competing with the far more efficient futures markets, but rather it appears to be an attempt to front run any other exchange traded gold fund in the USA. News reports have this new futures contract trading about 5.7 million contracts ($144 Millions USD) on the very first day, but I know of no one who participated.

The long long long awaited introduction of an Exchange Traded Fund in the USA has run into yet another delay, as yet another lawsuit has been filed claiming the misappropriation of "trade secrets", by Gemini Diversified Holdings, A.K.A., Mr. Dan Ascani. Needless to say, this lawsuit will probably have to be settled before the regulators allow the introduction of an ETF into the US markets. Since, by my count, this is the third lawsuit that has arisen so far, odds favor that we will see more. Hey, didn't I once mention the words "gold" and "investment" in the same sentence to some representative of the World Gold Council during a drunken reverie many years ago after a yearly gold dinner in New York? Hmm..perhaps I should get in line and sue. (Just joking)

Mr. Giacomo Panizzutti, who has been in charge of the secretariat responsible for the existing Washington Accord, which held Central Banks to a maximum of 400 tons per annum, stated that it was likely that while this agreement will be extended for another five years, the quantities of gold allowed to be sold will most probably rise to a total of around 2,300 to 2,400 tons. In my opinion, the market is thoroughly ready for such news and has discounted any moderate increase in official sales from this sector. While this was hardly news, this gentleman was also quoted, "I would not be surprised if they were to abandon the restriction on gold lending". If European Central Banks do indeed discard the restrictions on gold leasing, and perhaps scrap the prohibition on the increasing use of gold derivatives, it would have a rather large impact on the very structure and flavor of the gold market. After all, when the current agreement ends in September of 2004, official gold holdings of the signatories would still total 14,000 tons, about ½ of the total official reserves. I suspect that Mr. Panizzutti is right.

The platinum market catapulted up $22, to fresh 23-year highs, last week as the largest platinum producer in the world, Angloplat, announced that it was retreating from its previously ambitious plans to increase production in the coming years. The group dropped its production estimates by as much as a third, taking its 2006 production to 3.4 Million ounces to 2.9 Million. This projection was even worse than the analyst's consensus opinion. As such, platinum prices rallied sharply as the prospects for a continuing deficit between supply and demand stretches into the future.

As the platinum market is not the darling of investors, I would expect that the current higher prices will indeed ration demand, and that we will see fundamentals shifts soon occur. With this metal near $800 per ounce, it seems logical that demand for jewelry will somewhat abate, and with platinum now FOUR times the price of palladium, that we will see automobile manufacturers attempt to return to greater use of the cheaper alternative. These shifts will, of course, take some time.

With the platinum/palladium ratio now at about 4 to 1, instead of the historic ratio of about 2 to 1, a longer term trade presents itself by buying one and selling the other, on a spread. However, the timing of this trade is critical and it does not appear that now is the right time. It is important to watch this relationship, and when the market begins to move back to historical precedents, it will time to enter. Let the market tell us when, as the ratio just keeps getting larger in the past few months.

From the "everybody is on the same side of the boat" school, here is the latest Bullish Consensus (as of December 2nd)

GOLD 86% from 79% on November 25th
SILVER 76% from 68%
PLATINUM 81% from 82%

The statistics above show that a very large number of analysts and newsletter writers are bullish, a very large number indeed. There is an old cliché I took to heart many years that firstly, almost everyone "talks" their book, i.e. bullish if they are already long the market and already short when they are bearish, and secondly, if that many people have already bought (in the numbers above in re: gold, like 6 out of 7), how many are left to buy and push prices higher? The answer is not many.

While contrarian thought works quite well at major bottoms and tops in the market, it is only one arrow in a trader's quiver. As noted earlier, I take the numbers above, along with the reflections in my commentary given above, as just a caution. When attempting to forecast a market, it is essential to weigh all the various data points and influences. In some markets, at some times, a bullish consensus like the one above would certainly scream for a sell, in my opinion the percentages above constitute just a small caution, as the underlying trend for gold is so well defined and understood.

The Commitment of Traders reports, as of December 2nd, both futures and options:

Long Speculative Short Speculative Long Commercial Short Commercial Small Long Spec Small Short Spec
145,456 13,428 122,342 306,307 75,447 23,509
+9,040 +3,054 -2,206 +7,679 -3,105 -7,005

With prices up some $12.50 during the relevant period, the biggest buyers were the large speculative funds adding nicely to their positions as prices continue to rise, and the small spec shorts who finally exited their losing positions as gold rose past the magic number of $400. And, as usual, the sellers were the trade. Commercial Shorts added to their already large positions, and are now short just over 952 tons of gold or, think of it this way, about 40% of one year's entire gold production. I don't remember ever seeing it this large. Well, maybe a long time ago.

While this could be taken as a sign of extreme caution, I do not assume so. The historical ratios and traditional analysis of these reports just have not worked for quite a while. The trend has been that open interest increases mightily, prices keep rising, and commercial shorts just keep growing. That tendency has not shown any sign of changing.

Long Speculative Short Speculative Long Commercial Short Commercial Small Long Spec Small Short Spec
50,512 2,741 21,276 96,231 37,184 9,999
+6,861 +973 -5,251 -460 -3,488 -2,392

As in gold, the buyers were the large spec funds and the small spec shorts "giving up the ghost" on their short positions as prices went through the $5.50 price level. Although prices in silver largely followed gold's fortune, there is perhaps a hidden lesson in the numbers above. Please note that commercial longs were sellers of over 21,000 contracts. Now, let us think about when, and why, commercial longs sell futures. The answer is that since they are hedgers, they sell futures when they buy physicals. That means that there is at least good, or perhaps quite good, physical demand in the silver market. The statistics above imply that the bull case is better than most down-in-the-mud most fundamental analysts would infer.

Since silver has followed gold religiously, I continue to look for a trading range near-term. I would exercise caution and perhaps liquidate some of long positions, if they feel a bit "heavy". Recommendations will 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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