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Market Commentary

For markets of October 18th

Based upon 30 day maturities
DEC GOLD $420.10 GOLD .00/.50%
DEC SILVER $7.11 SILVER .50/2.00%
JAN PLATINUM $847.00 PLAT 1.00/4.00%
DEC PALLADIUM $218.35    

General Comments:

The precious metals were a shade lower last week even though the USD fell in price and even with oil prices continuing to rocket higher. The complete irrationality of the large speculative funds dominated most trading venues, and was especially seen in the copper market, where prices fell by almost 24 cents in just four trading days. We have this phenomenon many times, where large speculative funds drive prices to completely unsustainable and unrealistic levels, only to find no buyers when they wish to sell.

It should be explained that the overwhelming majority of large funds are simply "black box" traders, where a computer model dictates the trades. And, most of them rely on trend-following systems, where unlike a rational human trader; they continue to add to their positions as prices move in their favor. A rational human, who purchases gold, lets say at $400 per ounce, would recognize that at $410 the risk/reward analysis of the trade has changed, and would perhaps sell a bit of his position. This is the EXACT OPPOSITE of how most large funds trade. These funds continue to add and add to their positions, where by definition, they carry the largest long position at the very top of the market. Such insensitivity to logic, and the fact that they swing billions of dollars around, creates massive volatilities in the market, and many market moves are simply the result of their order flow.

These "black box" computer systems have no concern about the fundamental supply/demand considerations at all; they carry no concern about news events or governmental statistics, all they look at IS THE PRICE. And since it seems most trade quite similarly, and with billions of dollars behind them, many of the price movements seen in the market are just self-fulfilling prophecies. Realistic and careful analysis of the fundamentals of many commodities seems to be no longer valuable in ascertaining value in many of the commodity markets, all that you really need to know is when the funds are buying and when they are selling. Please give this some thought as it pertains to the Commitment of Traders reports, as the funds tend to be wrong almost all the time. Well, let's be more concise, they tend to be "ultimately" wrong, but have the capacity to drive prices both higher and lower than many think possible.

Gold prices fell by $4.40 for the week, failing to penetrate the massive technical and psychological resistance level of $425/$430. Trading conditions were, as you might expect, quite volatile with prices registering a range of about $14 from low to high. The large funds were the noted buyers, while the commercial trade were generally on the sell side. Silver, largely shadowing the gold market, fell from its lofty perch by 18 cents or so. Palladium suffered a $16 loss while platinum rose by $4 per ounce.

My view of the markets has been that we are still firmly ensconced in rather well-defined trading ranges in all of the precious metals, but that perspective must be reevaluated based upon the USD. As gold has had a 90%+ correlation with the Euro over the past three years, any convincing movement higher in the Euro is a warning signal that the trading range in gold may soon be broken. Another worrisome signal is the continuing price of oil, as gold has most certainly "picked up a bid" from those investors who rightfully understand that high oil prices will create an inflationary bias in the economy. While I remain rather steadfast in my original view, it is certain that the risks that the precious metals break out on the upside has sharply increased, but odds still favor a retracement as we are quite near the top of the our projected trading ranges. Should the USD hold the 87.00 level (more or less) basis the December contract, and if oil prices decline below $51.50 basis the November contract, then it will dictate that gold is still a sale at these levels.

As noted in earlier commentaries, the Chicago Board of Trade began trading gold and silver futures electronically on 10/06, attempting to compete with the Comex. As expected, their results are less than stellar, even in the first weeks. On the opening day, the CBOT traded 949 contracts versus the 50,608 traded at Comex. On 10/16, the new competitor to Comex saw 2062 trades verses the 52,365 in New York. Since the contracts are virtually identical, there is little incentive for either the trade or speculators to shift allegiances. The CBOT will be conducting a rather large marketing program in the coming weeks which may encourage participation. From a positive perspective, I have following the bid/ask spreads on the CBOT contracts and they seem to be QUITE GOOD, with the spread in gold often only 10-20 cents.

Even with gold holding firm in the last few months, the strength of Indian gold demand continues to surprise most analysts. In the past 5 months, most of the increases in the price of gold has been offset by the increase in the rupee, from under 43.5 in April to roughly 46.0 at present. This is a major contributing factor to continuing demand and total imports of gold into that nation could total 880 tons this year, up some 10% over last year. As the economy of India continues to thrive, it is likely that the currency will follow, and thus also likely that gold imports will continue to rise. Please remember that gold buyers worldwide think in terms of their own currency, and not in terms of gold in Dollars. A higher rupee makes it cheaper for Indians. As an aside, Indian households hold about 15,000 tons of gold, over 10% of total world above ground supply.

While the use of silver in photography is not all that important in the grand scheme of the fundamental supply/demand equation, it must be noted that Kodak's Chief Executive expects that demand for traditional film will drop by 16% per annum between now and 2007. By that time, over 75% of all imaging needs will be accomplished electronically. Another blow to the bulls in silver was the comments by Kamal Naqvi, of Barclays Bank, in this months Alchemist, to quote, "For the year to April, official Chinese silver exports have risen by 56% year-on year, spurred by the sharp rise in silver prices. The continuing rise in Chinese exports, notwithstanding some improvement in official records, appears to confirm the domestic silver inventories remain significant-and helps to explain why silver prices fall back so dramatically as soon as speculative buying dissipates" (emphasis added). So, in other words, while the fundamentals of silver dictate lower silver prices, the large speculators certainly have the ability to push prices higher, for a time.

We are beginning to see that indeed, the cure to high prices is high prices. We are beginning to see some reluctance in demand from the Chinese in platinum due to current price levels. Chinese platinum jewelry demand, which accounts for 20% of world production, has fallen off sharply.

Imports for the month of August were the lowest since April of 2000. Virtual Metals estimates that annual platinum demand will settle near 1 million ounces, down from 1.5 million last year.

The Commitment of Traders reports, as of October 12th, for both futures and options:

Long Speculative Short Speculative Long Commercial Short Commercial Long Small Spec Short Small Spec
171,655 24,295 110,843 305,667 71,098 23,633
+1,642 +921 -1,811 +1,060 +4,957 +2,807

While the "big boys" were very inactive during the week where gold prices fell by a bit over $3, the small speculators seemed to be the only players. This market continues to be overbought, based upon the statistics above, with long speculative forces now at 5.06 to 1 against the shorts. Historically, this ratio signals danger of the potential for a sharp break in prices, it signals vulnerability SHOULD the longs decide to exit en masse. But, it is far from certain that they will. As noted earlier, I would believe that the triggers in this market will be either the USD or the oil market and traders should watch those carefully. A move above $430 in gold will signal a sharp rally as there is much resistance to getting to that level, and if surpassed, we could well be on our way to $460 to $480. But, odds favor the alternative scenario. Recommendations will follow.

Long Speculative Short Speculative Long Commercial Short Commercial Long Small Spec Short Small Spec
62,796 4,502 16,501 97,598 35,228 12,425
+7,923 +678 -1,540 +5,108 -397 +201

Silver prices were little changed during the reporting period, but in contrast with gold, it was the large speculators who were the only buyers at prices exceeding $7.00 per ounce. This is obviously a very bad omen as historically the large specs NEVER seem to get this market right. With long specs now 5.79 to 1 against the shorts, this market looks quite vulnerable. But, shorting silver is extremely dangerous as the large funds can have their way with this market. However, there are perhaps some strategies to accomplish this.

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 December $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.

Expected trading range: $6.50 to $7.30

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. Highly aggressive speculators can be sellers on a close under $6.80 the December contract with a stop close at $6.95. But, be careful as this market is wicked.

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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