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August 10, 2004

Market Commentary
by Leonard Kaplan

For markets of August 9^th

General Comments:

The financial markets as a whole, and the precious metals in particular, are swaying to the rhythms of rosy optimism on one hand, to abject pessimism on the other, as governmental reports, and comments by Federal Reserve governors, have portrayed the US economy as either improving or declining. Two weeks ago, when Dr. Greenspan painted the picture of economic health and vitality, the USD rallied, sending the precious metals lower. Last week, weak GDP statistics and a shockingly bad employment report sent the USD sharply lower, propelling the precious metals higher. The precious metals have had little life of their own, as the gold and silver markets continue to shadow the movements of the Dollar.

Volatility has been vicious as thin trading conditions exacerbate the price movements. As an example, last Friday as news emerged that the US economy only produced 32,000 jobs against expectations of about 230,000, the Euro rose over 200 points, its biggest gain in over 2 years. Naturally, the gold market followed step for step, rallying over $7 to close the week near the $400 price level in spot. The silver market, the current darling of the large speculative funds, rallied over 21 cents, achieving highs not seen in 4 months. The sharp decline of the USD last week was not lost on the platinum market, where prices ran up by a bit over $14. The overwhelming influence of the precious metals continues to be the Dollar, with little else seemingly important.

But I continue to be awed by the continuing volatility of the silver market, with prices careening back and forth, with no apparent justification or rationale. Twenty cent moves in either direction, up or down, occur with great frequency and rapidity. This market is getting thinner and thinner as even the locals (traders on the floor of the exchange who trade for their account) are hesitant to participate. This only increases the danger of this market. As an example, my broker on the floor of the exchange reports that just 1000 contracts, 5 million ounces or about $33 million dollars in total value (please note that it would require only $2.7 million in actual cash as margin), would move this market by ten cents!! With large speculative commodity funds currently holding a minimum of $80 Billion USD or more, it becomes most evident that this is the "driving factor" of this market.

The gold market continues to look like a trading range, comfortable resting in the $380-$410 range after its bull market of the past three years. Well, perhaps it is more accurate not to portray gold as having been in a bull market but the USD as having been in a bear market. As readers of this commentary have read, my belief is that the next leg of the bull market will occur when gold begins to rally in most or all currencies, but until then we will mired in a well traveled and well defined trading range, which is certainly not a bad thing as it creates an trading environment that can be most profitable. The long-term secular bull market in gold is not over, it's just delayed. Sooner or later, the underlying economic fundamentals take precedence, and gold goes higher. But not for a while.

The financial markets are currently totally obsessed with the daily emotional dialogue as to how fast, how soon, how "measured" will the Fed raise interest rates. Just the hint of economic weakness and you see some financial pundits declare that the Fed will not raise rates in some month or another, and the USD plummets, pushing gold higher. A bit of economic optimism, or just the jawboning by a Fed official, is enough to rally the USD, forcing gold lower. What the financial markets have not yet grasped is that interest rates must rise by at least 200 basis points just to get back to normal, to some modicum of neutrality. My sense is that the Fed raises rates by 25 basis points at each and every opportunity until very late this year. Such actions will most probably keep the precious metals at bay, and keep the Dollar rather strong going into the elections.

Another striking negative for the commodities market is that growth in China appears to have peaked. JPMorgan estimated that manufacturing output virtually ceased growing in the April-May period for the first time in three years as the Chinese government is attempting to moderate the unsustainable economic growth rate. If the base metals or other commodities stagnant in price, it will change the psychological perception of the marketplace, and large commodity funds will be less likely buyers. Look for this to have a knock-on effect on the precious metals as well.

Amidst condemnation by IMF, other world bodies, and loud screams uttered by the miners, Chile's government has slowed down the legislative process that would require royalty payments for mining. Perhaps that nation should look carefully at what has occurred in South Africa over the past years, where layer upon layer of taxation, in one form or another, has hurt the industry. While the influence of a strong Rand certainly has punished many gold producers, please note that on an annualized basis, South Africa may only produce 338 tons of gold this year, down from 375 tons last year and 425 in 1999. The Chilean imposition of any royalty tax upon miners is likely to be completely counterproductive, as they may gain 3% of the value on ever diminishing production levels.

In an interview with Reuters, the economic advisor to the Prime Minister of Italy floated the idea of selling off gold reserves to help reduce the Italian government's debt, currently at 107% of GDP. Italian gold reserves total 2,452 tons of gold, the third highest in the EU. But not to worry, as this nation is already a signatory to the Washington Accord, and perhaps the market is already expecting 500 tons per annum. Just add the Italians in with the Germans and the French as those waiting in line to sell their "barbarous relic".

Of all the precious metals, the fundamentals for platinum continue to be strong. With China now accelerating their requirements for emissions controls in cars and trucks, this market should continue to see growth. Prices remain strong, and any major dips in the market are bought.

On to the Commitment of Traders reports, as of August 3rd, for both futures and options:

With gold prices fractionally higher during the period, open interest fell by over 8,000 contracts as the meandering gold price forced little change from the players. Large specs, both long and shorts, just swung a few thousand contracts back and forth between themselves, giving little information on which to make any forecast. Commercials were very quiet during the period, not surprising during the quiet summer months in the gold business. Of some interest is that fact that small speculators, both long and short, liquidated their positions most probably to each other. As the market was most quiet during this period, I would attribute boredom as the most likely reason for their departure from the market.

Here we go again. Silver was up 43 cents during the reporting period pushed higher STRICTLY by buying seen from the large speculative hedge funds. They were quite obviously the only buyer. This is an exact repeat of what happened 4 months ago when silver ran to $8.00 only to fall in just a few weeks back to $5.50. When the large funds want out of their positions, there will be no one to sell to and prices will plummet, yet again. The only question is timing, when will the first large sell order force the inevitable cascade of sell stops? This market is treacherous as you are depending upon the capricious actions of large hedge funds with way too much money in a market that has no fundamental demand at these price levels. Can prices go much higher? Yes. Will they inevitably fall back to a level that makes some economic sense? Yes. This is a much tested routine, and the end is always the same.

GOLD RECOMMENDATIONS:
Expected trading range: $392 to $404

In gold, I remain very slightly bearish as I see prices over $400 as near the top of the recent trading range. Certainly gold has picked up a "terror" bid as the Olympics begin and the Republican Convention kicks off, but that seems to be reflected mostly in the Dollar, and then translated into the gold price. I would change my opinion to neutral on a move into new highs over $408 and would become mildly bullish on a close or two above $412.

Its probably best to wait a bit before committing to the market. I would be a buyer on strength, and a seller on weakness. Look to get slightly short on a close under $400 basis the December contract, with a stop at $404. Call our offices for specific recommendations.

SILVER RECOMMENDATIONS:
Expected trading range: $6.40 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, the volatility of this market in thin summer trading conditions, it makes recommendations difficult. Although I remain bearish, I am cognizant that the foolish funds could drive prices well higher before they cascade lower.

PLATINUM 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 $780's for purchases.

Leonard Kaplan
Prospector Asset Management
1415 Sherman Ave. #504
Evanston, IL 60201
Ph: (847) 733-8400
Fax: (847) 733-8958

Prospector Asset Management, and its sister company, Prospector Metals LLC offer the following services:
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Futures Trading is for individuals willing to accept a higher level of risk for the opportunity of greater returns. This information is obtained from sources considered reliable, but its accuracy is not guaranteed by Prospector Asset Management. The recommendations reflected are those of Prospector Asset Mgmt. and are based upon circumstances it believes merit such recommendations. It is possible that other brokers or analysts may disagree with our opinions based upon their current commodity research or the analysis of commodity trading advisors. Expressions of opinion are subject to change without notice. Reproduction or rebroadcast of any portion of this information is strictly prohibited without the written permission of Prospector Asset Mgmt.

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