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Gold, silver surge as buck battered: Got Gold Report

Gene Arensberg
0 Comments| May 26, 2009

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HOUSTON -- The fearful rush out of just about everything and into the U.S. dollar last year (the fear of Armageddon trade) that propelled the dollar index up 27% from its lows near 70 to nearly 90 has morphed into a rush back out of the greenback - or so it seemed the past couple months. The sell-down of the buck accelerated this past week as the dollar index lost a stunning 295 basis points to close at 80.02.

When the Federal Open Market Committee of the U.S. Federal Reserve (Fed) announced it would be buying our own U.S. debt March 18, basically printing new dollars in very large numbers (while short-term interest rates are effectively negative and longer-term interest rates are rising), diluting all the existing U.S. currency, many felt it was just a matter of time before an exodus of sorts would get underway. Well, it is now officially underway - an exodus at the margin for now, but an exodus nonetheless of capital out of U.S. dollars into “stuff” and non-U.S. dollars.

When great wealth flees something it has to find a home in something else. We can look at the action in gold to see that some of that wealth now exiting the greenback has been heading into the one true “currency,” the one universally accepted standard and store of value.

Tactical “technicals”

Technically gold is looking better and better and in the two-year chart linked below we speak for the first time about an impending possibility that, until now was merely on the radar screen, but as of this past week that possibility has grown close enough to bring to everyone’s attention. While it very well may be a little premature, the setup has very bullish implications for gold metal if, repeat IF, it unfolds.

The problem for gold, of course, is that the market is thought by many analysts and market watchers to be managed, interfered with and manipulated by governments and central banks. Whether or not it is managed is more or less irrelevant when discussing our short-term trading positioning. It is even less relevant when discussing our longer-term positioning. What is relevant is how to best position if gold is managed, or if it isn’t at the same time. We’ll explain more over time for Gold Newsletter (GNL) subscribers, but longer term it probably just won’t matter if there is “management” of the gold price today.

Leadership lacking

The perception that the current administration, indeed most of the current cast of characters in Washington, are much more anti-business is growing. To put it in a catchy phrase possibly soon to be seen on CNBC, we now have a bull market developing on dismay, disappointment, disenchantment and disgust with our political “leadership.”

Year after year in order to get themselves elected our “leaders” have promised more and more “entitlements” to an ever growing number of voters who don’t even pay federal income taxes. America has run up its global credit card to the max and then some.

Our elected U.S. government has taken the world’s willingness to lend it wealth for granted. The world is not amused.

While mindful and respectful of these trends, we’ll leave it to other commentators and observers who thrive on such events to tell that vitally important story and instead focus this week’s report on changes in the physical metals markets and few of the technical indicators this report follows closely.

Premiums and contango

An interesting dichotomy has been developing in the gold and silver markets in the three weeks since the last full Got Gold Report. On the one hand, as gold and silver have risen sharply in price (as expected), we are witnessing an increase of supply of physical metal or at least a more balanced market between buyers and sellers at the retail level with the result that premiums, the amount over spot charged and paid by bullion dealers, have fallen back from near record levels just a couple months ago back down to or near pre-crisis levels this past week.

My friend Bill Haynes, of CMI Gold & Silver Inc., has been a gold dealer in Phoenix, AZ since 1973. Bill checked in this week via email and says: “The huge reduction in premiums on all products suggests reduced buying through out the industry. Higher prices seem to be factor with the increase in selling. As for premiums, they're back to pre-crisis levels. We're talking Gold Eagles and 100-oz silver bars, the mainstays of the industry.”

For decades my own go-to guy for bullion, Sonny Toupard of Royal Coin in Houston, agrees, saying that premiums have fallen and dealers are building inventory. As an interesting side note, Toupard said: “Scrap sales are down since these ‘home scrap parties’ are ripping people off along with the ‘mail-your-gold-in’ schemes” (Ed. Note: Sounds like an opportunity for some enterprising vulture lawyer there) .

On the other hand, there has been no corresponding negative money flow from the world’s gold and silver exchange trade funds. To the contrary, as detailed below we must take note of a little of the opposite while the futures contango’s for both gold and silver remain very tight.

Contango, by the way, is the condition where futures contracts for forward (farther out in time) months are more expensive than near months. Contango is the natural condition for precious metals as it reflects the cost of carry and storage in a stable market with adequate or ample supply. The opposite condition, called backwardation, where front months are more expensive than forward months, is thought to reflect a market with tightening supplies. Sustained backwardation is usually quite rare in gold and silver.

As of Friday, May 22, the difference between the June 2009 and June 2010 gold futures contract was a mere $7.40, or 0.8%, and down from $8.20 the previous Friday. So, as gold rose about $27 an ounce for the week Friday to Friday the contango actually bullishly contracted.

In silver the difference between the July 2009 and July 2010 contracts was just nine cents, or 0.6%, one penny higher than the previous week’s contango. As of Friday one could actually buy a futures contract in silver a year forward for a dinky nine-cent premium over the current July contract.

Big and short

Meanwhile, as the U.S. dollar has once again been taken out behind the barn and “shorted,” we have to take note that the very largest futures traders on the COMEX have seen fit to take on much larger net short positions for both gold and silver.

If we were to call the “play-by-play” in the precious metals baseball game, we would say that the big commercial traders now have the bases loaded on the “short side,” meaning that the largest silver and gold futures hedgers and short sellers have positioned themselves very strongly for lower gold and silver prices. At least they have vis-à-vis their positioning on the COMEX. (Should we be looking for them to swing for the fences or instead look for a “squeeze play” as options expire here in the U.S. on Tuesday?)

We cannot know the collective commercial trader’s relative positioning in the more opaque and much larger OTC precious metals markets based in London and Zurich and cleared through the London Bullion Market Association (LBMA). What we can see and measure is their relative positioning on the COMEX by itself, something Gold Newsletter subscribers have the benefit of just below in the gold and silver COT sections of the report.

The quickly-said upshot is that while we have seen another harsh dollar plunge and a nice bump higher in both gold and silver (as expected) since the last full report, the conditions we watch closely have deteriorated measurably in the indicators we give the most weight to on a short-term basis. As gold and silver have gone higher, so has the apparent opposition to them doing so in other words.

What does it mean? Longer term this report remains solidly in the bullish camp for gold, silver and mining shares. However, very short term the odds of a pullback have escalated to more likely now along with the escalation of the COMEX commercial net short positioning. “More likely” means just that, a pullback is not guaranteed. Indeed the current dollar weakness looks and feels like it may continue this time and that is a tailwind for both gold and silver. Technically the buck has “broken” and it really wouldn’t surprise this writer if the current rally in precious metals not only continues, but picks up steam in the weeks just ahead.

Don’t let profits evaporate

So, for our short-term trading positions it is time to raise trailing stops to at least a “near resistance” level in order to protect our hard-won profits should the “opposition” decide to stage a full-on attack very short term. A “near resistance” strategy is the second tightest of the stop levels we employ, second only to an “at resistance” stance. It means jamming the trailing stop up close enough to the trading to protect most of the unrealized profits, but still allowing for some ordinary daily volatility to occur.

A “near resistance” trailing stop strategy is not, repeat NOT, a sell signal. We are not at all interested in selling gold or silver. Not yet. Should a precious metals surge continue we want to participate, but if the market turns hard against our long positioning our stops will allow us to exit the trade to the sidelines, providing much needed ammunition for the next deployment of it.

Alternatively, one can “buy insurance” in the form of long-dated out-of-the-money puts as a hedge to protect profits. The peace of mind they offer is well worth the premium following a surge higher in most cases.

With that, let’s look more closely at a few of the indicators. (Please note this excerpt contains some, but not all the Got Gold Report charts, commentary and analysis).

SLV Metal Holdings

Silver actually opened lower to begin the week, printing a very slightly lower low of $13.64 Monday (5/18). From there silver had more trouble going down than up for the rest of the week. Friday’s $14.83 was the weekly pinnacle before settling out at $14.67, over $1.00 higher than the Monday low and a net weekly gain of 70 cents, or 5% (See the silver charts linked below for more technical commentary).

For the week, metal holdings at Barclay’s-sponsored (for now) iShares Silver Trust [SLV], the U.S. silver ETF, remained steady at a record 8,348.18 tonnes of silver metal held for its investors by custodians in London.

Click to enlarge

Source for data Barclay’s iShares Silver Trust.

Like GLD, the authorized market participants (AMPs) for SLV add shares to the float and increase the amount of silver held (in minimum basket amounts of 50,000 shares) to answer imbalances of buying pressure over selling pressure. So, we know that when the amount of silver being held increases, buying pressure is prevailing. The opposite is true when selling pressure overwhelms buying pressure.

Remember that Barclays, the sponsor of SLV, has agreed to sell its iShares division in an owner-financed (with 20% down) $4.4 billion sale to Blue Sparkle L.P., a Cayman Islands based company affiliated with CVC Capital Partners Group SICAV-FIS S.A., a private equity and investment advisory firm, with offices in San Francisco, California (CVC).

Regular readers will remember that we have been watching to see if and when SLV announces a new custodian because SLV has used more than the amount of storage space and silver metal allocated to them by JP Morgan Chase, London in the custodian agreement.

Here’s what we said in the last report: “While we wait for SLV to publicly announce who the new custodian will be (also the amount of silver storage space and the potential amount of silver to go in it that will be allotted to SLV by the new arrangement), we are left to wonder if the now growing awareness that silver supplies are in short supply will escalate right away or will instead still simmer just under the surface a while longer.”

Well, we are still waiting. Waiting for the new custodian announcement and waiting for the closing of that sale to CVC. We’ll report any new developments, if any, in the next full report. Meanwhile, just as a reminder, Barclays spokesperson Christine Hudacko told Got Gold Report in early April that, “To date JP Morgan Chase Bank N.A. has accepted all creation activity since the contractual limits outlined in the custody agreement have been reached, and currently we have no reason to expect that not to continue.” (Apologies to Ms. Hudacko for getting her name wrong in prior reports)

So, while SLV hasn’t yet named a new custodian, or an expansion of the existing custodian agreement, for now there isn’t any reason to think that SLV can’t add more shares and silver if buying pressure greatly outstrips selling pressure.

Natural gas warning shot?

What a ride natural gas has been on since our report three weeks ago, which suggested “NatGas” and the companies that produce it as a possible opportunity. Here’s the same chart we featured on May 4 updated through May 22:

Click to enlarge

In a quick six-day romp Natural Gas shot 33% higher from the $3.50s to the $4.60s and it looked for all intents like the “Big One,” the big reversal we are expecting for NatGas, was getting underway a little ahead of schedule. That was until this week and a much higher than expected 103 billion cubic foot injection reported by the EIA on Thursday took some of the bullish juice out of the NatGas market.

Interestingly, the several NatGas related companies this report mentioned in that particular Got Gold Report did indeed sell off with NatGas, but not one of them even came close to answering the commodity in percentage terms. What that means is that the market still seems to be pricing in a reversal higher for NatGas in advance of the fact.

The bad news? This short covering move higher was not the Big One. The good news? Folks have another chance to participate in a carefully constructed “buy-down” as we suggested in that report. An opportunity maybe up to when the first named storm of the Atlantic hurricane season shows, or perhaps when the first undersized NatGas injection shows. On either event the Big One is likely to get going in earnest as producers continue to curtail production and put off new drilling. Until then we get another chance to load the magazine for a potentially fun trade.

Easy does it. Adding small, progressively lower buy targets in incremental units is the game plan for this trade. Remember, while we are certain that NatGas is not heading to zero, the idea is to plan the attack so that you are glad if NatGas trades even lower than we expect. That means setting up the “buy ladder” to include prices that seem “too low” by at least one or two full handles.

One way to play is the NatGas ETF UNG. Here’s a graph:

Click to enlarge

That failed breakout that just occurred is important. It is important because it tells us the market wasn’t ready yet for NatGas to move substantially higher. It also tells us that when it is ready, the move could be very explosive. If NatGas short covering can move 33% higher in six days when it is not ready to break higher, can you imagine what it will do when it is ready to do so? The NatGas market rarely trades sideways at extremes. Instead it tends to be repelled very strongly in high percentages from them. In order to participate in the coming violent rally we intend to add into weakness in measured incremental units at progressively lower price targets AHEAD of the almost certain surge to come. That’s our game plan for NatGas in a nut shell.

If we know that NatGas tends to rally viciously off bottoms, the short sellers know it even better. Rest assured of that. Meanwhile, those with moderate risk tolerance can add some UNG in small incremental units on a liberal good-till-cancel buy-down schedule that takes advantage of harsh selloffs automatically.

We just don’t get all that many obvious and compelling opportunities in major markets like this kind of set up with NatGas, so we just have to take the opportunity, as it comes, and on its schedule. Essential to the trade is our confidence that the NatGas producers will over-answer the historic 76% plunge in prices, creating a new bull market as a new cycle begins.

Before hitting the send button on this offering (which by the way is being written on Saturday, May 23) here’s an idea of just how cheap natural gas has become in this historic plunge in price.

Click to enlarge

The chart above shows natural gas in terms of gold. By that measure gold has become extremely expensive relative to natural gas. Can gold go higher and NatGas lower? Sure, you bet they both can. But eventually will the ratio revert to the mean? Yes, we can certainly count on that too.

And oh yes, before I forget, congratulations are in order for Brien Lundin, Gold Newsletter head honcho and all around good guy. After what must be a decade and many trials and tribulations his beloved Natcore, a new technology company, began trading under the Canadian symbol NXT.V at 45 cents. Here was the press release.

If interested at all in what may be a breakthrough technology for "green energy," a patented technology developed right here at prestigious Rice University in Houston that Natcore secured the rights to, please do take the time to visit the Natcore website here.

If ever there was a political climate that is "friendly" to such things, it is now, in the U.S.A.

Got Gold Report Charts

2-year weekly gold
2-year weekly silver
3-year weekly HUI
2-year weekly Gold:HUI ratio
2-year weekly UNG

This week’s surprise small or micro-cap stock

That’s it for this excerpt of the Got Gold Report. Gold Newsletter subscribers enjoy access to all the Got Gold Report technical analysis, charts and commentary.

Until next time, as always, MIND YOUR STOPS.

The above contains opinion and commentary of the author. Each person should study the issues carefully and, as always, make their own informed decisions. Disclosure: The author currently holds a net long position in iShares Silver Trust, net long SPDR Gold Shares, net long ETN DXO, net long UNG, long Timberline Resources (TLR), long Paragon Minerals (PGR.V), long Forum Uranium (FDC.V), long a small number of Natcore, (NXT.V), long SDS as a Big Market hedge and currently holds various other long positions in mining and exploration companies.


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