a sobering article for pm bugs

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    Gold's stark warning to trend followers

    Neil Behrmann

    The gold market is at a significant juncture.

    The market has been given a rude awakening following the heady optimism which boosted prices to almost $400 an ounce. The sharp tumble in recent days has shaken large and small speculators and investors who'll now be wary of the dangers. The smart upward trend lines and moving averages on technical programs have proved to be precisely that- just lines.

    Prior to the fall, gold was trading in a range last seen in the mid nineties. Billionaire hedge fund manager George Soros and the late tycoon, James Goldsmith had bought substantial quantities of the metal early 1993 when the price was depressed . They succeeded in creating market momentum to push it above $400 an ounce, and gold generally traded within 10 per cent of that level until 1996.

    Once again hedge and commodity funds have been the main force in the market. Outsiders have to bet on the whims of these fund managers, so the price is exceedingly difficult to predict. Further dollar weakness could easily set gold on a path to $400 and beyond, but even though the metal has corrected from recent heights of more than $390, the risk premium has increased. In terms of euros, sterling and Swiss francs the move would be limited, since they would also appreciate against the dollar.

    Fundamentals poor as market bets on dollar

    Gold is thus very much a wager on the dollar. If dollar bears are correct and the euro appreciates a further 10 per cent, gold would have a good chance of topping $400. If the dollar euro rate bobs up and down within a relatively narrow range, it will see saw on hopes of speculators. The same applies to silver. Platinum (watch this space) is looking particularly toppy.

    The market thus has to guess the intentions of major hedge fund managers since supply demand fundamentals have deteriorated considerably at present price heights.

    Jewellery and other fabrication demand in India and other parts of Asia has contracted considerably. It improved slightly when gold dipped but buyers -even ahead of Diwali, the Indian Festival of Lights -were wary. The window for gold jewellery manufacture ahead of Christmas will soon close. The market will then have to wait several months for Chinese New Year. Demand is slightly better in Europe and Japan because currency strength has kept bullion relatively stable in euro and yen. But high prices have attracted sellers of trinkets and other scrap metal. Precious metals refiners are turning them into bars and this gold has to be bought by speculators and investors if prices are to move higher (see supply).

    Speculative positions have fallen but are still high

    This is why the market has become so risky. Indeed, large speculators began to take profits on their huge positions prior to the sudden tumble last Friday. (see below) On New York's COMEX, the derivatives exchange, total speculative and investment holdings, mainly held by hedge and commodity funds fell to around 13 million ounces at the end of September from a peak of around 17 million earlier last month. Including holdings on the Tokyo Commodity Exchange which raised exposure considerably in recent months and positions in London, Switzerland, Hong Kong and elsewhere speculative and investment holdings have fallen to around 15 to 20 million ounces from more than 25 million, estimate dealers. This is equivalent to approximately 14 percent total supplies or about a fifth of global mine production. So potential supplies from speculators and investors are still high.

    From 2001 to the middle of this year gold mines contributed to the sharp revival from the depressed 2001 level of $255 by reversing prior forward derivative sales that had been instituted to hedge or protect them from falling prices. In other words, producers were effectively supporting the market via purchases of gold derivatives.

    But US dealers report that producers have begun to take advantage of higher prices and are beginning to offload. Central banks are in the background.

    The gold trading range appears to be $365 to $390 an ounce. If the dollar were to revive, the price could test the lower levels. The outlook for gold shares, especially South Africa and Australia, where appreciating currencies have to a large extent offset the international gold price, is bearish. For gold stock holders, the price has to spike again.

    Neil Behrmann
    Editor of www.marketpredict.net

    10 October 2003

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