Kaplan's take

Last week may have seen the end of the most vicious decline in price for silver and gold in almost 10 years. Previously, the prices of both were rallying nicely, with the speculative and investment communities supporting the upward trends in prices. And suddenly on July 23rd, the debacle began, only to be continued into last week. There are many theories and thoughts as to how and why the gold and silver markets became so aberrant. Let me give you the one that I believe has the most credence, which is not to say to that other factors may have been highly contributory. As in all good stories, as in all good mysteries, there are usually unseen and unknown co-conspirators.


Historically, over the past several months, it has been only the buying by speculative and investment interests that moved the gold market higher. Please note that such buying and accumulation was extremely sound, being based upon a multitude of bullish factors such as a falling USD, a falling US equity market, the inherent bullish fundamentals of the gold market, less hedging by producers, etc…and a host of other bullish factors. But, it was investment alone that moved the prices higher, rather than underlying industrial/commercial demand, which was extremely poor, as demonstrated by the fact that in the past and current rally, gold lease rates barely budged off rock-bottom levels of less than ½ of 1% for a 30 day tenor.

Over the past 6 months, the large commodity hedge funds and most speculators were totally committed to their long positions, and all attempts to dislodge them were massive failures. Naturally, I, and other analysts, expected such trends to continue, as there seemed no trigger imminent that may force a change of opinion among the buyers. Ahhh….but I, and many others were wrong. The one thing about trading that I find so incredibly appealing is that as soon as you know the rules, they change them

As volatilities exploded in all the markets, from the wildly swinging 600, 700, 800 point days in the DJIA, to the sharp moves in the currency markets, and even to the uncharacteristically heady movements in the grains, the black boxes (the technically derived computer systems) that run a goodly percentage of all of the large and larger commodity hedge funds, issued a sell on all positions for the express purpose of reducing risk and limiting financial exposure. Any market that had significant investment of speculative interest saw massive amounts of selling, from copper to coffee to Euros to gold. The selling was indiscriminate and weighty. And to quote the scripture, selling begat more selling begat more selling and the gold and silver collapsed. For no other reason than that mentioned above. And without the support of the industrial and commercial interests, gold prices fell to the levels where such industrial interest would be rekindled.

In a truly spectacular justification of technical analysis, silver and gold prices both fell almost precisely to their 200 day moving average early last week, and then managed a bit of a rally. Gold is now $11 off its intra-day lows and silver about 6 cents off the lows. I look for gold and silver to now grind higher, in a return to the upward trend and a reversion back to the mean. I strongly believe that the worst is over for the bulls.

Gold was up $3.80 for the week while silver, suffering from its stature as a somewhat, sometimes, industrial metal fell by 7 cents as expectations of a global economic recovery dimmed. Platinum joined silver in its ennui, down about $3.50, but palladium collapsed by $17 as it seems that not only does no one wish to sign long term delivery contracts with the Russians, but also that Ford Motor is still selling from its inventory.

Perhaps the action in the platinum and palladium is indeed further proof of my theory of why the gold and silver market collapsed. During the swan dive perfectly executed by the gold and silver markets, platinum and palladium remained unperturbed, indifferent and non-responsive. Is this because these markets are primarily industrial in nature and participation by speculative interests is virtually nil? Yep, I think so.

Platinum and palladium seem trapped now, trading in rather extraordinarily tight ranges. On the one hand, expectations of both increased production in the coming years and a deteriorating global economy remain bearish factors, while a dropping USD makes them cheaper to all foreign buyers. Schizophrenically, I expect these markets to rally if investor interest is ever recaptured and I expect them to decline if it is not. Perhaps I have no idea of what I am saying as the last sentence seems to make no sense whatsoever. Perhaps I should try to do more of this as Alan Greenspan is soon set to retire. If no one can understand what he is saying, and if I could learn to be completely obtuse in my rhetoric, perhaps there is a job in it for me.

Earlier this year, the gold market was agog with the prospects of huge demand that could emerge in Japan from a change in the regulatory and insurance environment covering bank accounts. The outrageous expectations were, of course, unmet and gold demand was just a shade better than before on a tonnage basis. But, the wild-eyed touts saw this as only a harbinger of things to come as soon the Japanese government was going to eliminate all insurance on all bank accounts, and a frenzied rush to gold would soon appear. Well, now the Japanese government appears to be seriously backpedaling on such legislation. Please don’t look to Japan to provide any serious interest in the gold market. Its over.

On to the Commitment of Traders report, as of July 30th, for futures and options:

GOLD

Long Speculative
Short Speculative Long Commercial Short Commercial
28,437 24,398 83,281 123,221
-21,667 +4,655 +12,562 -23,112


Small Long Spec Small Short Spec
48,606 12,707
-13,712 -4,631


The statistics above are telling us nothing that we didn’t know before, but the numbers are simply staggering. As open interest declined by over 24,000 contracts, as prices collapsed, long speculators exited their positions in grand force as the trade, the commercials, bought over 35,000 contracts. It is eminently clear that prices, once forced higher by speculative buying, were simply forced lower by selling from the same source. And, in the end (drum roll, please….) the commercials were again right and most of the speculators were sheared of their wool. The age-old truism of following the commercials has, in the end, proven to be the best and most reliable path in trading. And now, that the speculators are home licking their wounds and the commercials are buying, we can go higher in price. The last few weeks were clearly a “bear raid” in a bull market, but uncharacteristically, it would appear that the specs did it to themselves and were not the victims of the commercials. You know, there are times when God shows himself (ok, herself) to the market as such elegance cannot be of earthly manufacture.

Nevertheless, after such numbers, I must believe that we grind higher in price now.