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Precious
Metals Wake Up
Admittedly,
a $4.50 pop in gold is not particularly exciting from a historical
perspective spanning the last thirty years. However, if you view
it in relation to gold’s 5-year characteristics, proponents of the
yellow metal are ecstatic.
However, enthusiasm may
be premature. While the 20-day and 40-day averages were exceeded
yesterday, the sudden rally just before another U.K. auction just
touched $266 from an approximate $256 bottom. Were it not
for today’s additional $3.00 rally, the move appears suspiciously like
a 50% retracement with $266 resistance if you measure from an
approximate $276 interim high.
God bugs point out that
previous U.K. auctions have been “significantly” over subscribed.
Yet, gold has not managed to hold onto gains achieved by initial
reactions to auction enthusiasm. The post auction environment has
consistently failed to hold strength. Again, bugs claim the
environment is substantially different because average global interest
rates are exceptionally low. This means the “opportunity cost”
associated with holding gold is minimal compared with gold’s potential
as a hedge against rising prices. The recent increase in the CRB
Index is used as a “warning” that inflation pressures are mounting.
Equally important, the Euro is blamed for a bounce in European retail
prices because conversions are always rounded up. Until consumers
balk at the slightly higher pricing, merchants are content to take their
windfall. This is viewed as an incentive for Europeans to move
into gold.
In the old days, gold
would probably have soared to $1,000 and ounce with the complete
conversion of Western Europe’s major currencies. However, we
must remember that an entire generation has grown up without gold.
Those who are 30 years old today were toddlers when gold was legalized
for ownership in the U.S. in 1975. The generation that grew up
during the Great Depression is far smaller and less significant than it
was twenty years ago. This is why precious metals have remained
“under reactive.”
Fundamentally, silver
took the lead by rocketing approximately 65¢ from its lows. All
the while, gold seemed reluctant to follow. The argument was that
silver was well below production costs and we allegedly ran two
back-to-back deficit years.
In reality, producers
were simply unwilling to sell below $4.25. The concept of
production cost is somewhat amorphous because silver is primarily a
byproduct of other metals. Depending upon cost allocation, silver
can be $4/ounce or $0.50/ounce. The wide difference results from
capital depreciation and overhead. The actual extraction may be 30¢
to 50¢ per ounce if you only consider hard cost for energy, chemicals,
and processing. This makes silver a fundamental “moving
target” when attempting to extrapolate an appropriate selling price
based upon cost. In effect, the price is whatever producers are
willing to sell for.
Interestingly, the
deficit numbers do not seem to reflect the surge in digital imaging that
has begun to transform the photographic industry. Apparently,
digital cameras are supplemental rather than substitutive. Those
who own digitals still have their 35mm film cameras. Disposables
are selling at their highest rates to suggest that film is far from
dead. Yet, companies like Kodak and camera manufacturers have
jumped onto the digital bandwagon with predictions that film will,
indeed, retire over the next decade. Industry sources say that the
huge leap in quality coupled with the dramatic decrease in cost will
supplant film by default.
The problem has been,
and remains in processing. While it’s okay to review the
vacation on a computer screen, the snapshot remains the standard as does
the picture album. Until this standard output can be conveniently
reproduced, people will continue using film. It is possible to
email digital photos to a processing lab and get them in the mail just
as one would do with a film canister. But, 1-hour development is
not mainstream, yet. Kodak and other manufacturers are installing
digital output devices in drugstores, malls, and supermarkets.
Eventually, this will take a toll on silver consumption.
The real innovation and
problem for silver stems from industrial imaging applications.
From X-rays to lithography, processes are relying upon digital rather
than film. Thus, industrial usage is likely to decline more
rapidly than consumer photography. As mentioned in my book, The
New Precious Metals Market (McGraw Hill), I am not a proponent of buying
and holding silver. This metal remains a speculative trading
vehicle.
Silver’s explosive
rally from November’s $4.05 low was expected. In fact, I made an
attempt to buy the breakout just as prices fell back 8¢ from $4.20.
Each attempt met with a stopout as intra-day volatility exceeded my
conservatism. Indeed, it is another case of being right, but
wrong. Now, silver seems poised to test $5.00. Having not
seen this level in more than a year, it could be an achievable goal.
While it would be nice
to participate in this launch, I point to the post September 11th rally
that achieved similar lofty levels. With some visible resistance
at $4.78, I am not sure the timing is appropriate. It may be wise
to sacrifice the move toward a $5 test in case the current trend
exhausts. If the previous pattern is an indication, we could see a
change in slope before the turn as indicated by the curve in September.
Alternatively, we might encounter a “V” top just as we saw the
November “V” bottom. Given the precipitous fall from the
October high, is the exposure worth the risk?
Copper is another one
that sliced and diced us. After assuming the long side from 6940,
prices promptly plunged to double-bottom at 6555. Having made a
small consolidation under the 20-day and 40-day averages, it appeared
copper was ready to retest below 6550. As quickly as copper
dipped, it rallied again. Chop, chop.
Having spiked
significantly higher on news that London inventories had been drawn down
more than expected, copper is, once again, “flagging.”
However, this time it is an upside breakout that seeks technical
confirmation. A long awaited move above 7350 paves the way for the
sacred 80¢ test.
Is the economy booming
enough to justify 8000 copper before the March expiration.
Assuming housing continues brisk, the major offset is a downturn in
autos. Along a more amusing note, I read a brief analysis that
asserted copper would rise with the introduction of new copper-based
computer chips that were supposed to be released last year. These
“new generation” CPUs are likely to become the standard, but even a
billion units won’t add up to much copper when considering the
extremely small amount of metal in each chip.
There are few things
worse in trading than the whip-saw. Having picked copper wrong
twice, re-entering the long side is difficult. Technically, the
flag remains a bullish pattern until 7000 is violated. The
“pole” from 6550 to 7250 projects to 7950 resistance. That’s
a pretty good move for copper. While the chart supports this
possibility, I remain uncomfortable about the fundamentals. Chile
and Peru are major producers. The Argentine devaluation is
indicative of a more diversified South American malaise. When
countries need money, the recourse is to sell anything that is
available. Notably, copper.
Grains
Our enviable
accomplishment has been the bull wheat spread taken at 8¢ July over.
This has deliciously inverted to 8¢ March over for a 16¢ gain on $150
spread margin. It’s not over ‘til it’s over.
Typically, a squeeze puts March at a 20¢ to 40¢ premium. On rare
occasions, it widens further.
The massive snows that
blanketed Buffalo, NY pushed eastward and missed a large swath of winter
wheat that currently suffers from dry conditions. South
America’s weather has become less certain as we approach critical
stages for corn and, later, soybeans. When I recommended the wheat
spread, I pointed out that the U.S. had relatively small acreage over
the past two years. Any weather disturbance would translate into
an inverter or “backwardation” condition.
This logic was shared by
many skilled commodity traders and brokers. Unfortunately, some
traders jumped into wheat before September 11th and were caught by
extraneous influences. This is exactly why the spread made more
sense. Don’t forget that there are very big players. For
example, Cargill was conspicuously missing from the market during the
4th quarter rally. After speculators were shoved out by the
decline, the price was right and Cargill stepped in.
Speculators were
“suckered” into positions as wheat broke out in July. The
carryover from winter 2000/2001 was perceived as limited and we were
going to wait an entire season for fresh supplies. In addition,
wheat was cheap.
When the summer grains
were projected to be better after some trepidation, wheat became a
casualty despite the fact that it is not a summer crop. The
pre-attach consolidation convinced traders that the 50% retracement was
in. Just as they bought, the bottom fell out right through to the
October lows. All the while, the spread remained unblemished.
After all, 8¢ July over was close enough to carrying costs to limit
downside risk.
After considerable
noise, many traders look upon the current “pennant” as chart relief.
Finally… a recognizable pattern! This projects to 3.16 if
you assume 2.92 is the beginning of the pole. Even at 3.16, many
believe wheat is cheap. The critical period for root damage will
be upon us from late January through February. Any thaw followed
by a hard freeze could severely limit the crop’s size and quality.
On this fear, alone, March wheat can easily touch 3.45 and higher.
Alas, many would-be wheat traders are so severly shell-shocked, they
simply can’t lift the phone to give another “buy” order!
Interest Rates
Just when it seemed long
term rates were in a trading range, March T-notes put in a vigorous
rally to challenge above 10600. Coincidentally, we were selling
the 106 strike. Fortunately (or not), we didn’t reach our entry
objective of 1 and 50/64ths. This provides another opportunity to enter
if the price falls back. Now that March notes have bounced above
the 20-day and 40-day, I am less inclined to strangle the options.
Frankly, the move into
U.S. Treasuries was supposed to be in reaction to Argentina’s
devaluation. If this is the case, there certainly was a delay in
reaching the market! Anyone who thinks interest rates reached
bottom should take another look at Eurodollars. If the FED’s
ultimate goal is to flatten the yield curve, we should join the rally.
Email:
Phil@commodex.com
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