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Market Commentary

For markets of September 7th

Based upon 30 day maturities
DEC GOLD $402.50 GOLD .00/.50%
DEC SILVER $6.59 SILVER .50/2.00%
OCT PLATINUM $859.40 PLAT 1.00/4.00%
DEC PALLADIUM $212.30    

General Comments:

The last week of summer saw some interesting times in the precious metals markets, although participation by investors or speculators was about as light as expected. The gold market rallied during the week on large scale buying, at both the exchange in New York and over the counter, by one or more large bullion banks. It faltered on Friday as the monthly release of the employment numbers bolstered the USD. It is generally believed that much of the institutional buying of gold last week was due to the collapse of an Australian gold producer (who had sold about 1.3 million ounce of gold forward), and the resultant covering of those short positions by the counterparties to those trades, locking in the losses.

Gold prices only fell by about $3 for the week, just a minor loss, tracking highs seen at about $411, to lows just under $399 per ounce. While this market continues to see its greatest influence from the Euro, divergences were seen with gold remaining stronger than expected, due perhaps to the institutional buying of gold as noted above, perhaps to the renewed strength of oil prices, and perhaps a greater palpable fear of terrorism as the Republican convention continued. Another possible explanation is that some astute investors have begun to feel the nagging onset of possible inflation, which historically boosts gold prices as investors seek refuge.

With gold tracking a minor loss, silver obediently followed, losing only 4 cents for the week, although a 25 cent range was seen from the highs earlier in the week to the lows on Friday. As in recent months, this market remains quite thin and the flow of orders creates largely unexplained and unnatural fluctuations. Platinum and palladium were also moderately lower in trading dominated by Far Eastern interests.

In the Telegraph, an Indian newspaper from Calcutta, I found this graphical representation of many aspects of the gold market, and I believe it represents an excellent primer on some supply/demand fundamentals of this market.

One important caveat is that jewelry demand is not quite as simplistic as is thought by Western minds. In most of the world, notably India, the Middle East, and the Far East, jewelry is bought primarily for its gold content, as an investment, and not really and truly as an adornment. For buyers in these parts of the world, jewelry is simply a convenient method of storing value in gold, as coins or bars are relatively unknown. After all, you might as well wear it or exhibit it shamelessly rather than keeping it locked away in some vault. So, while private investment in gold depicted as being only 15% of the total world supply (some 140,000 tons or so), in actuality the total is much higher.

After YEARS of waiting, it appears that soon a gold-backed fund may soon be trading on the New York Stock Exchange. Details are sketchy as of yet, but it appears that State Street Corporation will be the marketing agent with HSBC in London storing the gold. Presumably, it will be modeled after the Gold Bullions Securities product that trades in London and Australia, but perhaps not. There is NO indication that any of the "fatal flaws" of the original fund have been addressed, notably the taxation issues or the inability of pension plans to participate expeditiously. Hopes for this product are truly "over the top", even though the like products in other countries have had little to moderate success. But wait, there is more competition coming, as Barclays Global Investors has filed a registration with the SEC for a product that will mimic the price of gold futures on the exchange in New York. All of these machinations seem to me to be absolutely ludicrous, seem to me to be failed attempts to re-invent the wheel. It is more than evidently clear that the most cost-effective, most transparent, most liquid, and most heavily beneficially regulated market is still the Comex in New York. I maintain my view that the World Gold Council would have been much better served promoting gold ownership by partnering with already accredited and recognized partners rather than attempting to procure new methods for investors to easily own gold.

UBS, a most knowledgeable participant and analyst of the gold market, recently proclaimed that the participants in the Washington Accord (primarily European Banks) may sell materially less gold than their self-imposed quotas of 500 tons per year, perhaps only 250 tons. I remain confident that they possess information not readily available, but historical precedents continue to convince that all of the gold will be sold, one way or the other. If they are correct, then the reduction in sales should compensate for the slowing pace of producer "dehedging" (the process by which they reduce outstanding previously sold gold positions). And if correct, such reduction in sales would materially change the supply/demand fundamentals to a minor extent, and would change the "psychology" of the market to a very major extent. The market takes the view that most of the Central Banks of the world will be sellers, to some extent, forever and any shift in perception would be most bullish. As an aside, when the Central Bank of Argentina bought some gold recently (just a small amount), the news cascaded through the gold market enflaming the hopes of many gold bugs.

On to the Commitment of Traders reports, as of August 31st, for both futures and options:

Long Speculative Short Speculative Long Commercial Short Commercial Long Small Spec Short Small Spec
135,840 24,076 120,172 274,809 63,841 20,968
+6,755 +5,635 +1,645 +5,974 +2,808 -402

In a week where gold prices rose by about $7.50, with open interest climbing by about 11,700 contracts, the data demonstrates that it was purely speculative buying that forced prices higher, and not any material physical demand for the actual metal from either the investor nor the commercial/industrial user. And, AGAIN, as such, it was the hapless speculator who bore the brunt of his folly as gold prices are now $10 less. Again, commercials, who know and understand the market much better, who trade without emotional import, were right and the speculators were wrong. After decades of watching such activity, I begin to wonder when the large speculative funds will stop beating their heads against the wall and learn just a bit.

I maintain my current view that gold is NOT in a bull market at this time, but rather in a welldefined and well-traveled trading range, let's say $380 to $420, more or less. As gold prices were above $410, it was clear that small short positions were advantageous and last weeks commentary was dead on target in recommending as such. With a failure at the top of the range, I would look for gold to continue lower for another test of the bottom of the range, where positions should be reversed to the long side. It isn't all that complicated. With USD interest rates rising, the USD will be supported, or at worst, will languish at or near current levels. With the very high historical correlation between gold prices and the Dollar, it remains unlikely that gold can rally on its own, at least at this time. Specific recommendations will follow.

Long Speculative Short Speculative Long Commercial Short Commercial Long Small Spec Short Small Spec
52,136 1,679 17,246 92,116 34,960 10,548
+1,680 -480 -3,894 -2,992 -2,563 -1,646

With silver prices only minimally higher during the reporting period, and with open interest dropping very sharply (usually a most negative signal for the silver market), there was little change in the ownership of positions on the exchange. The Long commercials and the short commercials just effectively traded positions (this is most often the result of long hedgers taking delivery of physical product, previously bought, with the short commercials delivering from their inventories, covering short hedges). The speculative crowd was clearly absent.

With prices falling off their highs, this market still looks quite vulnerable to long liquidation, especially if gold follows my thoughts and moves lower. I would be a very cautious seller here, especially on a close under $6.50 basis the December contract. As always, recommendations will follow.

Expected trading range: $395 to $415

Last week, I recommended small short positions at the $412ish price level, and traders who follow our recommendations now have $10 per ounce profits. Look to cover ½ of the position at $401 to $402, and let the other half run down to technical support at the $397 range basis the December contract. Look to start nibbling on the long side in the very low $390's. The December $425 calls now are most profitable and looking good. When we get into the buying range noted above, start the long position by selling out of the money puts, perhaps the December $370 or $375's. Please call our offices for specific recommendations for your account.

Expected trading range: $6.10 to $6.70

Again, we see how this market operates, with the funds driving prices up to unsustainable price levels only to see the physical market disappear, the commercials become sellers, until the inevitable wash-out occurs. With the capriciousness of the large funds, the volatility of this market in thin summer trading conditions, it makes recommendations difficult. At this point, it is worth taking a shot for the downside. First, sell the November Silver $7.00 calls, and then sell December silver on a close under $6.50, and use a 10 cent stop. My initial target on a convincing break of $6.50 is the $6.10 to $6.15 range. Call our offices for specific recommendations.

Expected trading range: $800 to $855

Prices seem rather strong here, and if gold and silver decline, then it is likely that platinum will as well. I really don't want to get short this market, so we will wait for a buying opportunity later. I am still looking for the low $800's for purchases.

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