Tuesday Kitcommentary – What SAY You?

The flames of volatility turned into a veritable firestorm of price gains and declines on Monday as the new week got underway and Tuesday’s opening action showed no indications that the hectic pace of change was about to abate.

Gold and silver continued to cover a large price spectrum as the morning wore on, with the former trying to hang on to the $1,500.00 level while the latter raced across a $2.50+ range that basically extended from $44.60 to $46.30 per ounce. On Monday and during the overnight hours the silver story was much the same; a frenzied spike to very near $50 followed by a near 12% insta-collapse down to the mid $44 area.

Late Monday market analysis revealed a string of five days during which the average Daily Sentiment Indicators remained at 97%. Such extreme levels have not been noted for circa a quarter of a century in the white metal. In the words of Elliott Wave Editor, technician Steven Hochberg, the vertical price rise and an extreme in optimism is potentially "ultimately lethal for those who believe that they can outrun the impending reversal." Silver has been on a speculative tear since Valentine’s Day and it remains the focus of most financial media and commentary headlines. Hopefully, latecomers to the silver party will not experience the characteristics of a long-gone, other…Valentine’s Day.

Speculative activity in gold and silver gained traction as reflected in the latest CFTC reporting period’s mention of an increase in net length in both metals. Gold’s net length is above the 800 tonne level, whilst the one in silver has exceeded 6,400 tonnes. Spiking gold price tags have begun to pose a buying dilemma even for the traditionally gold-friendly Chinese investor.

Meanwhile, the CME has recently increased margin requirements for silver, but that did not come as much of a surprise to participants. The majority of the gain in speculative long positions last week came from short-covering and was not attributed to fresh buying. Gold’s possible push towards the $1,525-$1,540 price targets could be in jeopardy if silver does undergo a sharp decline and manages to drag the rest of the complex down in sympathy.

Technical support levels in the metals are currently indicated at: $1,493.00/gold, and at $43.55/silver. The action might intensify later in the day as we are on approach for COMEX options expirations. Standard Bank analysts note that "important strikes" are concentrated at $1,500 and at $1,520 in gold and at $40 and $50 in silver respectively. Ergo, the basic requirements of a strong stomach and a stout wallet are essential, while patience and courage are priceless at this juncture.

Platinum fell some $10 on Tuesday, easing to near the $1,800 level as some sympathetic selling became manifest and as players appeared to still digest the implications of the news that global auto giant Toyota will likely not resume full vehicular output until the year’s end. On the other hand, the market was mildly buoyed by the reporting of FoMoCo’s first quarter profit of $2.6 billion based on robust car and truck demand. High gasoline prices do not as yet appear to have deterred US auto buyers from showrooms and have not managed to dent consumer confidence, as noted in the latest Conference Board report on the subject. The confidence Index hit 65.4 this month, versus a showing at 63.8 in March.

The weekly CFTC trading positioning data suggests — according to Standard Bank SA market analysis — that the noble metals are starting to "look overstretched on approach to $1,850 and $800 respectively." Also of note this morning was the fact that precious metals sank despite a further slippage (of 0.3%) in the US dollar on the trade-weighted index (to 73.90 at last check) and a still-resilient crude oil price tag up above the $112.00-per-barrel-mark.

The focus among market players now shifts to tomorrow and to the microphones in front of which Fed Chairman Bernanke will respond to questions, during his first regularly scheduled press conference designed to convey his institution’s policies. Nervousness about the possible future course of Fed monetary policy, about tightening moves already in motion in India, China, and the EU, and about what the Chairman might or might not say on Wednesday, managed to snap a four-day-long rising streak in commodities this morning. QE2 has, in large part, played a role in the commodity space spike the markets have been witnessing since late last year. The Fed meets today and tomorrow and Mr. Bernanke goes in front of reporters following the end of the meeting.

"We think core inflation will remain subdued, with the result that headline inflation, which is rising currently, will turn down again once the increase in oil and other basic commodity prices ends. That is what happened in the last two oil price run-ups, in 1999-2000 and in 2007-2008."

No, we did not employ the crystal ball or time travel to bring you Mr. Bernanke’s words from tomorrow. These are merely the suggested words to be used by the Fed Chairman, in the view of Lyle Gramley, a former Fed Governor.

Another set of similar suggestions for Mr. Bernanke have been made by David Malpass, the President of Encima Global LLC. Mr. Malpass –in referring to what Mr. Bernanke ought to say about the on-going weakness in the US dollar- recommends that in lieu of deferring dollar-related talk to Treasury, Mr. Bernanke should chime in and say:

"Yes, I would prefer a stronger dollar and lower commodity prices, especially gold and oil, in order to attract capital and jobs to the U.S."

Meanwhile, no need to guess ahead what Mr. Geithner has to say about US deficits. He made it quite clear already, in a remark made today at the Council on Foreign Relations in New York:

"You have to commit to bring the budget deficit down to a level that will put our overall debt burden on a declining path as a share of the economy."

That said, Mr. Geithner warned that:

"the biggest mistake that countries have made coming out of a crisis is to shift too quickly rather than phasing in budget cuts over time." The Treasury Secretary also made mention of the fact that crude oil prices have "become an obstacle to growth for the US economy, which is otherwise set to accelerate."

We close this hectic morning roundup (replete with computer "issues") with a stark report by the Bank of Japan on the subject of the recent surge in global commodity prices. The study, produced last month, delves into the effects of accommodative central bank monetary policy and contains several cautionary passages that are well-worth jotting down at this juncture.

The corollary statement of the study is that "it is safe to say that globally accommodative monetary conditions are a key driver of the rise in commodity prices by stimulating both physical demand for commodities and investment flows into commodity markets. Equally, the financialization of commodities, as demonstrated by the rapid increase in commodity futures investments by financial investors, has amplified the fluctuation of fundamental factors, thereby amplifying the price fluctuations."

One of the reasons why this week’s Fed gathering may be more important than it appears to be at first blush, is that the interest rate environment has been pivotal to the aforementioned surge in prices.

Moreover, cautions the Bank of Japan document, "When coupled with a prolonged low-interest rate environment, enhanced market expectations may entail a reduction in risk perception of investors who view commodities as an investment asset class. This causes commodity prices to significantly deviate from the level explained by fundamentals, otherwise called a "bubble."

As Forbes analysis concludes, "The Bank of Japan warns that rather than being an inflation hedge, the influx of investor money into commodities has changed the commodities markets from being an inflation hedge into an underlying cause of the current global inflation surge. The report warns that a possible result of speculative commodity trading is like "a vicious, self-fulfilling cycle, in which growing inflationary pressure drives more financial investors toward commodity index investments for an inflation hedge, which further accelerates inflationary pressures."

Thus, we conclude that it is time to say: Until tomorrow,

Jon Nadler
Senior Analyst

Kitco Metals Inc.
North America

www.kitco.com and www.kitco.cn
Blog: http://www.kitco.com/ind/index.html#nadler