Market Commentary

By: Leonard Kaplan | Tue, Jun 15, 2004
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For markets of June 14th

Based upon 30 day maturities
JUNE GOLD $386.60 GOLD .00/.50%
JULY SILVER $ 5.748 SILVER .50/2.00%
JULY PLATINUM $797.60 PLAT 1.00/4.00%
JUNE PALLADIUM $219.55    

General Comments:

The mood of the precious metals markets continued to darken last week, with all the precious metals falling in value as the US Dollar managed roughly a 2% gain, as forecast by this commentary. Gold prices were lower by about $5 as good selling was seen at levels above $393 to $395. Silver was uncharacteristically rather quiet, with prices down by only 6 cents and volatilities much reduced from the recent manic trading seen in past weeks. Upon hearing of impending inflation rates in China, and the fear of impending interest rate raises, platinum and palladium were cruelly victimized by very significant fund selling, which has oversized effect in markets as thin as these. Twenty-two dollars was shaved off the platinum price in rather quick fashion, as palladium shed $25, about 10% of its value.

With comments by several Fed governors last week, echoing comments by Alan Greenspan, the entire psychology of the markets has changed. While the financial markets once wondered if the Fed had the fortitude, or the ability, to raise interest rates aggressively, the market now is beginning to understand that the Fed may indeed act assertively, perhaps forcing interest rates up to as high as 2.25% by the end of the year. With inflation rates begin to show more than a bit of a sign of moving higher, with employment numbers vastly improving in the past three months, it has become a certainty that quite soon the USA will have higher interest rates, thus provoking a very significant downward pressure on the precious metals and on commodity prices in general.

As interest rates in this country rise, it creates numerous negative influences on the precious metals. And, this commentary has been quite vocal in stating that a goodly amount of the explosive rise in the commodities markets has been that money has been too "easy", too cheap. Firstly, as USD interest rates rise, it is VERY likely that the Dollar will follow. As gold prices have been very highly negatively correlated to the USD, gold would look to fall as that currency regains some of its lost ground. Second, in the competition for capital, rising interest rates and a rising USD, certainly makes investment in gold a bit less desirable, especially as many analysts in the industry are calling for a consolidation of the recent bull market, and not the continuation of one. And lastly, rising US interest rates will create higher contangos (the difference between the "spot" price and the deferred delivery value) in the gold market, thus encouraging gold producers to perhaps once again hedge their production, especially since gold has been falling of late. While the mood has somewhat darkened, I still see this market as a rather broad trading range for some time into the future, with excellent physical demand setting a floor near the $370-$375 level, and technical resistance lurking at $420 and above.

All that has changed is that now the probabilities of a significant rally in the gold price have deteriorated, and this market appears, in my sense, to be fairly equally balanced between the bull and bear case. As such, the secular bull market experienced in gold over the past years has been, temporarily, transformed into one where a trading range dominates the price activity. This is an extremely beneficial change for the shorter-term investor or speculator as dips in the market can be comfortably bought, and rallies easily sold. If done correctly, there is always more money to be made in trading range markets than volatile and difficult to forecast bull or bear trends. These markets now lend themselves to the quick and adroit professional who can adapt to the current structure of the markets, rather than to those who stubbornly hold old ideals.

I must admit that I find it fascinating to observe just how the market is now interpreting accelerating inflation rates. Now, any rise in inflation rates does not have the effect of propelling speculators/investors into hard assets, but, current thought dissuades them from those investments. All else being equal, the fear of the Fed aggressively raising interest rates far out shadows the reality of higher inflationary rates in the minds of investors. At present, a higher CPI or PPI will actually help the USD to go higher as the market will see that as justification for the Fed to be pro-active and assertive. It is as if the USD has developed some truly awful, life threatening disease, and the markets are more afraid of the short term pain of the medicine rather than the disease itself.

Yes, such interpretations seem totally perverse in a purely academic world, but for now, the financial markets care very little about inflation but are totally obsessed with the fear, and the reality, of sharply increasing interest rates. While the precious metals have historically been the darling of investors during inflationary eras, such will not be the case until investors realize the importance, and begin to look beyond the immediate ramifications. It's a complicated world, and the markets especially so as they are the compilation of the actions of illogical people. But for now, odds favor the precious metals to continue tracking the Dollar, and that looks to go higher, even if for the wrong reasons.

Investment, or speculative, success in these current markets depends upon interpreting just what is, and what is not, important. Reliance upon historical precedents, and old interrelationships between asset classes or various commodities just doesn't work too well anymore, and yet, such relationships are often used as justifications for gold to do this or do that. As an example, in years past, there was a distinct correlation between the price of oil and the price of gold, as oil prices dominated investment thought of inflationary expectations, thus pushing gold prices higher. I recently saw an article that proposed that gold was set for a massive rise as it was " out-of-whack" with oil prices, and must, of necessity, quickly regain the historic correlations. What the author failed to understand is that inflation, whether actual or perceived, is not important to the markets at this time. Yes, higher oil prices will certainly create higher inflation, but higher inflation will NOT, at this point in time, create higher gold prices. Just look at a price chart for the last 6 months in both of these markets. Be very cautious of analysts who resurrect ancient analogies and expect them to now operate efficiently. A good investor, a professional speculator, must understand the current rationality (or irrationality) of the markets in order to succeed. In my 30+ years career of trading, I have found that the very worst traders were professionally trained economists, who insisted that the markets must follow some ordered and structured path to their logical conclusions, instead of understanding what the markets wanted, or desired, or feared.

Gold prices will go higher if inflation becomes the dominant or preeminent "theme" in the markets, and gold prices will decline if the fear of higher rates forces the USD higher. I expect that both will happen, with one theme following another in rather haphazard fashion. As such, as mentioned earlier, we trade in a range. Look for the other metals to do much the same as strong fundamentals, and good physical demand contain the downside potentials. Without significant investor interest, there simply will not be the internal structure to force prices all that much higher, at this time. But the greatest truth about the markets is that things change quickly, perceptions shift and fears grow and recede. Good thing that this is a weekly commentary as predictions grow exponentially more difficult as you look out into the future.

On to the Commitment of Traders reports, as of June 8th, for both futures and options:

Long Speculative Short Speculative Long Commercial Short Commercial Long Small Spec Short Small Spec
83,679 35,734 124,811 208,733 59,920 23,943
-1,631 +1,571 -1,687 -3,808 -1,717 -2,798

During the relevant week, gold prices declined by $3.70 as open interest staged a most moderate decline. The changes in ownership of contracts on the exchange were most minimal, and I would venture that there was not much to be learned from these statistics. The ratio of long specs to short specs is around 2.6 to 1, well down from three times this statistic when gold was at its highs.

A new website has emerged that does excellent work on the Commitment of Traders report, and I recommend it highly. Try, and demos are available. From that site, I was able to pull this graph depicting just how decisively the large spec funds influence the price of gold.

Just a casual perusal of the chart not only demonstrates the pricing power of the large spec funds but also clearly shows just how often they are wrong. Please notice how often they have their LARGEST positions at the highs in the market, and how they often have quite minimal long positions at the lows. Yes, while it is true that such could be considered a self fulfilling prophecy, the lesson to be learned is that the successful trader wants to trade against them, not with them.

Long Speculative Short Speculative Long Commercial Short Commercial Long Small Spec Short Small Spec
32,781 10,049 19,888 71,864 39,668 10,424
-766 +2,227 -298 -5,375 -918 +1,166

During the reporting week, silver was down some 28 cents, and quite amazingly the speculative longs did almost nothing, maintaining their bullishness on this market. Short commercials were the biggest buyers as, evidently, the physical market reawakened. I see this as a bullish signal and a justification for my opinion that we have reached a temporal bottom, more or less, in this market. In silver, as in no other market that I follow, the commercials are almost always right, while the speculators are most often wrong. Its time to bottom pick a bit and recommendations will follow.

Expected trading range: $382 to $396

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Expected trading range: $5.60 to $6.25

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Expected trading range: $800 to $840

(positions and recommendations are available to clients and subscribers only)


Leonard Kaplan

Author: Leonard Kaplan

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

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