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Market Commentary

For markets of November 8th

Based upon 30 day maturities
DEC GOLD $434.30 GOLD .00/.50%
DEC SILVER $7.505 SILVER .50/2.00%
JAN PLATINUM $851.90 PLAT 1.00/4.00%
DEC PALLADIUM $217.70    

General Comments:

The precious metals markets continued to rally last week, largely mirroring the very significant declines in the USD. The financial markets are, and have been, completely ignoring all cyclical considerations of the US economy and are fixated, perhaps rightfully so, on the structural defects, notably the "twin deficits". With George Bush reelected, the market believes that the USD will head considerable lower as it fell by 35-40% during the first term of his presidency. With the government's policy of benign neglect as to the value of the USD, the market is now convinced in a continuing devaluation of the currency. This is most clearly seen in the almost historic record speculative positions in long gold, long Euro, and long Swiss Franc on the exchange. And, clearly, as the USD fares, the precious metals either benefit or suffer.

Surprisingly, the financial markets seem to be centered on the longer term implications of current trends rather than the daily news events and governmental reports. Last Friday was a superb example of this new phenomenon, as the job report was incredibly favorable for the USD. The Euro immediately fell over 1 cent, then rallied about 2 cents, to close into new record highs. It was clear that traders were taking every opportunity to short the USD that was presented. As the Euro made record highs, the gold market also rallied, carrying prices to 16 year highs. Even with the certainty of higher US interest rates coming promptly, the USD was rapidly and viciously sold, even in the face of fabulously bullish news. Gold finished the week up $4.90.

Silver continued its native volatility, with prices careening between $6.92 low to about $7.50 high during the relevant week. Its movements were largely a shadow of gold with speculative trading the most important feature of this market. While gold managed 16 year highs, silver is still well over $1 under recent highs seen earlier this year. Platinum also benefited from the overall rally, up some $18.90 for the week, and palladium rose by $5.50.

During the past months, I was inherently bearish on the precious metals when they approached the upper end of their trading ranges. The gold market had attempted on numerous occasions to penetrate technical resistance levels, and historically had failed. ODDS favored it would be so again. Owing to market action over the past week, I must alter my opinion on gold, to modestly bullish. I would now be a buyer on any dips, looking for prices to rally to the $460 price level. I remain cautious as the "breakout" in the gold market is due, strictly and solely, to the decline of the USD and NOT an intrinsically bull market in gold. As global currency values can be politically motivated and movements are not always dependent upon market fundamentals, the gold market is vulnerable to sharp declines due to massive long positions held by speculative forces. But, all in all, I would now be firmly in the bull camp now, but with carefully crafted stop losses placed into the market. Specific recommendations will follow below.

There is also the danger that the market may, at some point, become focused on more timely issues rather than the long-term. With the certainty of US interest rates rising, it is just possible that the USD may find some support, and any rally in the Dollar would naturally curtail, or postpone, the bull trend in gold. Although truth be told, this seems unlikely at this point in time, unless the Fed takes a much more aggressive stance in raising rates than is presently considered in the market. As long the Fed stays "behind the curve", which is to say that US interest rates stay below the rate of inflation (thus creating a negative "real interest rate"), the Dollar will suffer and gold will shine.

Of all the indicators for the gold market, the one most reliable seems to be the nature of real interest rates. If you believe the governmental reports on the Consumer Price Index (and few do, including myself), we have negative real interest rates now. If you believe that inflation is in fact much higher (as I do), then interest rates are even more negative. In the current environment, where investors are guaranteed losses on any short-term debt instrument investment, there is simply no reason for them to hold Dollars, and no reason not to pursue investments in alternative venues that have a much better chance for capital appreciation. This is the prime psychological driver to the markets; there is little reason to hold Dollars when inflation is higher than the interest received. With the stock market uncertain, with most debt instruments certain losers, the large speculative funds, along with individual investors, have flocked to the commodities markets and pushed prices higher. And, there seems little reason for this trend to reverse itself at present.

There is little doubt that the gold market is being driven by investment and speculation at present, as physical demand remains lackluster currently. Reports from India, the largest demand center in the world, bemoan the high prices during their Festival season and reports are saying that demand has fallen some 50-75% over the past week or so. Indian buyers tend to never chase rallies, instead they are buyers on dips in the market, and I would expect that prices closer to $420 would bring them out in droves.

Besides Exchange Traded Funds already existent in London and Australia, we now have a new entry in South Africa. These securitized "paper gold" investments are meant to encourage investors to buy gold in a format that supposedly eliminates much of their discomfort in buying either futures or physical gold. Even though the past year has seen a most significant rally in the gold market, even though the precious metals have received greater recognition by the press than in decades past, these funds remain, at best, only very moderate successes. After over a year, there is only 60 tons of gold held in custody for these funds, only $835 Million Dollars at present value. Of course, great hope is held out for such a fund in the USA, when it finally gets regulatory approval. But, my bet is that it does not meet the rather wild eyed expectations held by some in the market.

On the other hand, the investment vehicle that offers the best protection to the investor, the greatest transparency, the lowest cost, and the greatest liquidity is proving itself to be most successful in attracting business, as it should. Futures trading at Comex surpassed its previous annual volume on Friday with over 12.2 million contracts in one day. Investors and speculators will continue to seek market efficiencies.

On to the Commitment of Traders reports, as of November 2nd, both futures and options:

Long Speculative Short Speculative Long Commercial Short Commercial Long Small Spec Short Small Spec
181,551 30,402 112,152 306,606 69,561 26,257
-10,730 +5,356 +1,191 -12,667 -1,171 -3,399

During the reporting week, gold closed down about $7 as open interest contracted just a bit. Large speculative funds were the noted sellers, while short commercials were the buyers on the dip in prices. The ratio of long specs to short specs was 4.43 to one, high but not excessively so. Historically, when this ratio surpasses 5 to 1, it signals a major danger signal and significant vulnerability in this market. With the commercials buyers during the week, it also indicates some grass-roots physical demand in the marketplace, another good sign.

As noted earlier, I remain cautiously bullish now that we have achieved 16 year highs and have crossed most significant technical resistance levels. Specific recommendations will follow.

Long Speculative Short Speculative Long Commercial Short Commercial Long Small Spec Short Small Spec
61,333 2,877 20,741 101,581 35,525 12,942
-5,842 -2,912 +1,261 -2,094 -962 -536

As in gold, the large funds were the sellers while all other categories were buyers on the dip in price seen in this market. The ratio of long specs to short specs in this market was 6.12 to one, quite high historically. With large specs long so much, this market remains vulnerable to a sharp sell-off (not terribly rare in the silver market), and presents greater risk. But, all in all I look for silver to follow gold mostly. Overall, I would be a buyer of silver on a dip, rather than on a rally.

(recommendations are available to clients and subscribers only)

(recommendations are available to clients and subscribers only)

(recommendations are available to clients and subscribers only)

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