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Market Commentary

For markets of October 4th

CLOSES INDICATIVE LEASE RATES
Based upon 30 day maturities
DEC GOLD $421.20 GOLD .00/.50%
DEC SILVER $6.943 SILVER .50/2.00%
JAN PLATINUM $860.40 PLAT 1.00/4.00%
DEC PALLADIUM $222.80    

General Comments:

The last week saw the precious metals markets soar higher as large speculative commodity funds, hedge funds, and individual speculators placed huge bets that news or comments emerging from the upcoming meeting of the G7 (with China invited as a guest for the first time) would transform the current financial markets. These "players" were huge buyers of foreign currencies, wagering that the G7 would rail against the USD, and warn against the unsustainable economic impact of the large "twin deficits" of the USA. Another driving factor in last week's rush to the currency and precious metals markets was the thought that just perhaps the Chinese government may change, even to a small extent, their currency peg to the USD. There were even extremely foolish rumors, most centered on the internet, that the USA would announce a devaluation of its currency.

The buying frenzy was almost apoplectic in nature, pushing gold up $11.50 for the week, past the technical resistance at $416.80 (the old high in December Gold), and at one point through the $420 price level in spot gold. As is usual, these speculative forces were buyers near the top of the recent trading range for gold (lets say $385 to $425) and historical precedents would dictate that they are most probably wrong. On Monday, when the G7 announcements were much the same as the past, rather milquetoast, gold fell by $5.60 quickly. Some of the positions taken last week were immediately unwound, and the precious metals and the foreign currencies plummeted in value, as the USD rose.

Although this will be no cheer to the bulls in the market, I would expect that the odds favor a continuing retracement of the precious metals prices, all else being equal. Over the past year, every time the funds have poured into these markets, always near the highs, pushing the limits of their abilities and hoping for the long awaited "breakout" of the gold market, they have been humbled. In fact, as we see in the Commitment of Traders report, long specs may now total 19 million ounces of gold, now close to the all-time high seen earlier this year. The chart below is a technical chart depicting the "trading envelope" of the gold market since February of this year.

Please note, that with very little exception, that while the gold market has indeed seen a most distinct uptrend from May of this year to the present, the top band of the trading channel has not been convincingly breached. Each attempt for higher prices resulted in this market declining at least below the midpoint of the channel. Now, of course, this time might be different, but odds favor at least a small to moderate downdraft based upon historical precedents and based upon the knowledge that the large speculative hedge funds hold almost record long positions. Now, of course, this time could be different, as exogenous factors such as news, terrorism, or the continuing rally in oil may force gold higher. The gold market is most vulnerable at these levels, as the large speculative forces might lose confidence, and a cascade of selling erupt. Although, truth be told, it is hard for me to envision a break of the $400 level unless we see oil totally plummet, or the USD rocket into new highs.

Since the gold market has had over a 90% correlation in price movement to the Euro, perhaps the following chart better depicts the well-known and well-traveled trading range in which we find ourselves.

Since June of this year, the Euro has been ranged by the low 1.19's on the bottom, and about $1.25 on the upside. Simply, if the Euro breaks out above $1.25, I would expect gold to follow, but until it does, odds continue to favor that the gold market is at or near its highs. With the economic numbers still favorable in the US, with the Fed Reserve still resolute in their drive to raise rates, the USD should find some support, which will most probably keep the gold market contained. Just yesterday, Philadelphia Fed President, Anthony Santomera, was quoted, "I don't think that we are yet at NEUTRAL (emphasis added), we still have a way to go". Experience has taught me that the most important determinant of a currency's value is the current and projected interest rate that is carries and, as such, the USD may remain either stable or higher. And, following very convincing precedent, we can expect gold to be contained.

Silver, being the "darling" of the speculative funds, and a much thinner market, was pushed 52 cents higher last week, to approach the technical and psychological barrier of $7 basis the December contract. Monday saw the price decline by about 18 cents, again as some of the bets placed last week were unwound. Again, the COT's will demonstrate that this market is almost completely speculatively driven, and long term readers of this commentary know very well what happens when the funds decided to sell. They find very few willing to buy. Silver will most probably share the same fate as gold, following its movements although with greater volatility.

With the potential strike by platinum miners in South Africa, on one day, off the next, and then on again, platinum prices were higher by $8.60 for the week, not reflecting the $32 range from high to low in this market basis the January contract. As of Tuesday morning, this strike is on, but is expected to end shortly, as most do. Palladium ignored all the festivities and closed down $1 for the week.

Last week also saw the resurrection of a rather old idea that the IMF should sell, or revalue, its gold reserves to aid in the debt reduction of Highly Indebted Poor Countries. This supranational organization holds over 100 million ounces of gold, currently valued at only $40 per ounce, a most tempting stash of value. This concept dates back to the mid 1990's, and received a rather cool reception then and now. However, this notion has the backing of the World Bank, who has recently engaged in revaluations of gold holdings for both Mexico and Brazil. But, all in all, the gold market ignored this news as the possibilities for any sales are most improbable at this time. After all, any true market sales, which would certainly hurt the gold price, would hurt just those nations who may be benefited as many are gold producers themselves.

Gold sales by Central Banks appear to be accelerating as the gold price moves higher. The following by the World Gold Council:

Q1 and Q2 in 2002

295.80 tons

Q3 and Q4 in 2002

186.20

Q1 and Q2 in 2003

252.40

Q3 and Q4 in 2003

282.40

First 4 months in 2004

108.9 tons

Then annualized.......................

326.70

While I admit that it may not be totally valid to annualize the Central Bank sales of the first four months of this year to achieve a yearly composite, perhaps it does illustrate a trend. And, please note that the above information includes the purchases of gold by the Central Bank of Argentina of 42 tons. However, a disturbing notion is that even if 326 tons of gold are indeed sold by the Central Banks this year, this represents just about 1% of the 31,736 tons officially held. On the other hand, 326 tons represents about 10% of annual demand.

On to the Commitment of Traders reports, as of Sept. 28th, for both futures and options:

GOLD
Long Speculative Short Speculative Long Commercial Short Commercial Long Small Spec Short Small Spec
129,322 18,413 119,818 275,481 64,741 19,988
+15,877 -186 -10,516 +6,414 +434 -432

Gold was up over $10 during the reporting week, as open interest fell slightly. Please note that is a minor negative in the precious metals, as solidly based rallies usually occur as open interest expands, not contracts. Looking at the data above, it is VERY evident that all of the buying was done by large speculative funds, and all the selling by the commercials. This has historically been a recipe for disaster, as the funds find few willing to buy when they wish to sell. The ratio of spec longs to spec shorts is 5.07 to 1, another danger signal. I find the above information quite bearish, although I do not foresee a major decline imminent. Recommendations will follow.

SILVER
Long Speculative Short Speculative Long Commercial Short Commercial Long Small Spec Short Small Spec
34,869 4,744 20,049 77,088 37,032 10,119
+2,165 -1,827 -536 +3539 +463 +379

Long Small Spec Long Short Spec Silver was up 24 cents or so during the reporting period, as ALL the buying was done by large speculative interests. Although there is still room for the specs to buy more, as they are not near historically high levels of participation, it is not certain that they will. I see silver continuing to shadow the gold market, although with greater volatility. I do find it interesting, and in contrast to the gold data, that half of the buying by the large funds was short covering. But, overall, it is the commercials who are worth following in this market as the specs are almost always wrong. I remain negative on this market at these price levels.

GOLD RECOMMENDATIONS:
Expected trading range: $408 to $420

No matter what your predispositions in this market, it makes sense to be a seller. If quite conservative and long the market, sell a portion of your holdings hoping to buy back lower. If a bit more aggressive, sell a bit more. If a bit more aggressive, then sell out of the money calls, preferable the November $425 or $430 calls. And if very aggressive, go lightly short at these price levels with a stop above the recent high seen last week.

I remain bearish but with targets just slightly below current market prices. As mentioned earlier, my immediate target is in the $403-$408 on the downside. Call our offices for specific recommendations for your account. Look to start selling out of the money puts as we approach the $400 support level.

SILVER RECOMMENDATIONS:
Expected trading range: $6.50 to $6.90

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, and the volatility of this market, it makes recommendations difficult. At this point, it is worth taking a shot for the downside. First, sell the November Silver $7.00 calls, but lightly. Highly aggressive speculators can be sellers above $6.85 basis the December contract with a stop close only above the current highs. But, be careful as this market is wicked.

PLATINUM RECOMMENDATIONS:
Expected trading range: $810 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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