Precious Metals Report Leonard Kaplan Prospector Asset Management
For week of Monday, April 14, 2003
GENERAL COMMENTS:
As the global financial markets cease their unrelenting fascination with the Iraqi War, we are seeing an intellectual reversion back to the underlying fundamentals of the market, rather than the wild volatile swings recently seen due to the emotional irrational exuberance or illogical dread which permeated the financial markets upon every headline emerging about the war. To a large extent, the short-term large commodity funds, and the novice speculators, have now left this market, after they rocketed the price of gold to the $390 price level, only to have it retrace the entire move, back to the $320's. It was sure fun while it lasted, but professional traders will not miss their departure, as the markets are now more knowable, more easily forecast, and will NOT have the extreme risk and volatility associated with the fast money crowd. The gold market, having digested all the recent speculative activities (and perhaps regurgitating a goodly number of the speculative longs), can now revert to its original secular bull trend, with prices grinding higher over time.
As such, due to the bullish underlying fundamentals of gold, precious metals prices were higher virtually across the board. Gold gained $6.50 for the week, a rather impressive performance, and closed over $8 off its lows near technical support at the $320 level basis the June contract. As the USD weakened, as the equities markets declined, gold was carried off its lows, to mount an attack at technical resistance levels at the $328-$330 price level. Silver, which continues to shadow gold's price movements, as it really has no life of its own, was up over 7 cents, as that market really seems to want to move higher to the upside of its recent trading range, but still has technical chart resistance at $4.50-$4.52 to overcome. The platinum market, as expected, rebounded sharply this week, up almost $14 once the long speculators, who had dominated price activity for the past few weeks, finally sold the last of their long positions. Palladium was very quiet all week, with prices closing just about $1 lower.
In a release this week by a noted firm, it was estimated that the global hedge book in gold, dropped by 14% (to 2,509 tons) in 2002. Such large re-purchases of previously sold gold, or the reluctance to initiate new forward sales, was the shining pillar of support in this market, as gold producers were buyers of 408 tons of gold in 2002 versus the total investment demand of 341 tons. Gold producers, bought more gold than was even offered by Central Banks who are participants in the "Washington Accord," where their sales were limited to an annual total of 400 tons. I find it highly ironic that the very entities that are the major sellers of a commodity are now the supporting price influence. But, there is still over 2,500 tons of gold sold forward on global hedge books, about equal to one years production. With gold now relatively "cheap," with the prospects for a continuing bull market, with USD interest rates at 40 year lows, and with the USD and the equities markets looking like they want to go lower, it is quite easy to imagine that this bullish influence will continue unabated in the coming years. But, as we have written many times, "de-hedging" by the gold producers and jewelry offtake will not create a rapidly rising bull market, for that, we need the investment demand, which has not occurred yet. Until the global investor "steps up to the plate," I imagine the gold market will continue to grind higher in a slow and steady fashion, not that I mind at all.
As most professional analysts of the gold market now believe, it appears that Germany's Bundesbank will NOT be a seller of gold in the coming years. The other major potential sellers, France and Italy, have shown no interest in the disposition of their gold reserves. As such, there exists the potential, not the certainty, that the Washington Accord will not be extended when it expires at the end of next year, as there might be few Central Banks willing to sell. After all, the bulk of gold sales during the current agreement has been Switzerland, the seller of 1,300 tons of the total allowable of 2,000 tons. By the end of next year, they will be done, and it appears that no one dares to take their place.
There are good arguments on both sides of the coin as to how the gold market would interpret the non-renewal of the Washington Accord. Some say that this would only bring greater uncertainty and insecurity to the gold market, thereby damaging the chances of a continuing bull market. And there are those who see the reluctance of European Central Banks to sell, which makes the renewal of the present Washington Accord a rather moot point, as an extraordinarily bullish factor. It will be interesting to see how the markets interpret this event, if and when it occurs.
Official gold sales during 2002 totaled 556 tons, and any diminishment of this total, would have very significant effects on the gold price. Just remember that global production of about 2,500 tons/annum is still short of total gold demand of about 3500 tons/annum and that the deficit is currently accommodated by Central Bank sales and the recycling of scrap, and that any change in these two factors could move the market in a most dramatic way. With global gold production scheduled to decline very marginally over the coming years, a slowly rising gold price would do most to dissuade the Central Bankers from selling, and would also discourage the active recycling of scrap. The fundamentals of this market could be changing noticeably in the coming years.
Just for a moment, let us look at the gold market from a very long perspective. As per the World Gold Council, there are about 140,000 tons of gold above ground, mined since the dawn of creation. In just the last 21 years of so, 16,900 tons of gold have been mined, amazingly about 12% of the total ever created. In the past two decades, the marketplace has had to absorb this rush of new production in a macroeconomic financial environment where "hard" assets were completely shunned and discredited. Add to the pot the historical fact that these two eras saw very significant Central Bank selling of gold, throw in that gold producers amassed the very largest hedge books in history, and one has to be somewhat surprised that gold prices actually held up as well as they did. Current gold prices are STILL below their 20-year average achieved in a time period when all was against it, and, it is most unlikely that the environment for gold can possibly be as negative as it was for the past few decades. All in all, I find this train of thought to be rather bullish. It is perhaps a bit too simplistic, and its logical deductions could be challenged, but, I think it works.
With gold producers noticeable absent from the forward markets, with the "gold carry-trade" long dead, and with few speculators willing to short gold at these levels, lease rates in gold are again hitting historic lows, with the one-year interbank rate at about .25%. SG Warburg wrote in a recent commentary, that "some central banks are seriously beginning to question lending opportunities, even on long-dated maturities." Should the lending "pool" of gold sharply contract, that must be considered a bullish influence for the gold market as time goes by. However, it is much more likely that any contraction in gold supply created by the diminishment of gold loans would simply force lease rates higher, thereby re-encouraging the lending by Central Banks. But, all in all, should we see higher lease rates for gold with USD interest rates at 40-year lows, we could certainly see a dramatic change in the forward rate for gold, or "contango." With 1-year Libor at 1.25% or so, just imagine what would it be like if lease rates rose to that level. You would have a market where the 1-year forward rate for buying/selling gold would be equal to the spot price! At that point, there would be NO opportunity "cost" for owning gold, carrying a position would become free. And, investors and speculators would be strongly lured into the market, on the long side. The current secular bull market in gold is different than any bull market in the past, as prices have continued to move higher without higher lease rates. If lease rates for gold do indeed rise, as seems quite likely (after all, does it really make much sense for Central Banks to lend gold at these rates?), it would provide yet another justification for higher gold pricing.
With gold prices now at "value" levels, down from the lofty levels of $390 per ounce, the recycling of gold in India has now reverted back to historic levels of about 20% of the total annual demand of about 850 tons. A study by the World Gold Council revealed that the "recycling" of gold reached levels of about 50% of the total during times last year, and probably earlier this year as well, as prices were too high and too volatile for the Indian jewelry buyer. As such, with this resurgence in demand, the gold market should have a more stable "floor," as physical buying should prevent any significant downturn in prices. And, in India, it appears that the National Commodities and Derivatives Exchange, being promoted by one of the prominent banks after allowing legislation by the government, may begin in June. The liberalization of the gold market in that nation has proceeded slowly, but is moving forward.
After being a "state secret" for decades, news has it that the Russian government is preparing to reveal data on its stocks, production, and sales of the platinum group metals. Please note that such disclosures, if they ever occur, will NOT include Gohkran, the state precious metals and gem depository. Now call me skeptical, call me crazy, but I think the chances of the release of this information are totally nil IF such information is at all bearish for the platinum and palladium markets. Based upon the history of attempted and real manipulation of these markets by the Russians (who produce 70% of the global supply of palladium, and 30% of its platinum), this new release of information will be crafted to bull these markets, so the Russians can sell into the higher price. Anyone who expects the altruism of the Russians will be sorely disappointed.
On to the Commitment of Traders reports, as of April 8th, both futures and options
Gold
Long Speculative 41,677 +2,604
Short Speculative 20,366 +4.971
Long Commercial 103,411 +466
Short Commercial 155,324 -1,894
Long Small Spec 54,092 +384
Short Small Spec 23,491 +377
The statistics above demonstrate just how quiet the gold market has been recently, with volumes down sharply. During the reporting week, gold was down about $12.50 and open interest climbed fractionally higher by about 4,500 contracts. Speculative concerns were the only real sellers, while the commercials were buyers to a very small tune. It appears to me that the market is taking a well-deserved respite after the wild party of rocketing to $390, only to retreat to $320.00. I remain very friendly to the upside in this market, but significant technical resistance exists at the $328-$330 price level, followed by more at $335ish. I still believe that the best way to trade this market is by selling out-of-the-money puts and recommendations for both futures and options are listed below for clients and subscribers to the newsletter.
Silver
Long Speculative 27,520 +2,858
Short Speculative 20,351 -714
Long Commercial 32,994 -1,280
Short Commercial 55,621 +2,521
During the relevant week, silver was up about 4 cents and open interest rose by a meager 2,700 contracts. Long speculative concerns were the buyers, while their purchases were accommodated by the commercials, NOT a good sign for the bulls in this market. However, this is the first time in quite a while that the large speculative concerns are actually net short in this market, at the time where prices are near historical levels of both technical and fundamental support. IF these shorts can be induced to cover, we could go sharply higher. But that is a very big IF. More than likely, silver will just continue to drift sideways in a most boring fashion, following the gold price to a major extent. However, taking that assumption, there are excellent trades that can be made in this market that would take advantage of the current malaise, and recommendations will follow.
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