Gold, Silver, Metal Prices: Commentary – 12/16/2009

Markets Speak Ahead/On Behalf Of Fed

Good Day,

Gold prices ticked about 1% higher during the overnight hours as the US dollar pulled back ahead of the Fed decision announcement due later today. Yesterday’s surge in the dollar was notable however, and so was the fact that gold fell amid news of an unexpected rise in the PPI. The pre year-end trade shows all the conflicting signs that can be attributed to the cashing in on profits, window-dressing and/or book-squaring, and some ‘one for the road’ pile-on trades that speculators are noted for, around office eggnog season.

The midweek session in precious metals opened with gains in gold. The yellow metal was quoted at $1129.90 per ounce basis spot bid in New York, for a gain of $6.90 while silver moved one dime higher, to start the day at $17.49 per troy ounce. No change was recorded in platinum, which was quoted at $1447 while palladium climbed $4 to $367 and rhodium added $20 to $2060 per ounce. The market remains on Fed-watch and the range-for the time being- is seen as $1120-$1160 per ounce. Choppiness will likely not be absent as we head into the afternoon hours.

Observers at GoldEssential.com noted that during the overnight hours the market had "seen good evidence of a revival in physical demand from India and Vietnam at the dips, which certainly has helped to underpin prices, and have lured some speculative bargain hunters back into the market. The move through the $1,130 an ounce resistance layer overnight has equally seen some short-covering in tight market conditions, which has supported the uptick." Such demand from India later dissipated, as afternoon would-be buyers crossed their arms and pined for the day (yesterday) when they might have picked up some metal for near $1110 per ounce.

Consumer prices in the US rose by 0.4% last month — a figure that was in line with economists’ expectations. Shortly after the data release, the US dollar climbed a tad higher on the index, rising to 76.80, while crude oil maintained gains and held near $71.25 per barrel. Housing starts rebounded in November, rising 8.9% after they had fallen by more than 10% in October versus the previous month. The mixed bag of economic offerings continues, albeit the trend looks markedly brighter.

The disconnect between the inflation signal seen on Tuesday and gold’s peculiar performance on the same day did not go unnoticed over at Marketwatch, where Mark Hulbert noted that: "Gold’s behavior Tuesday just goes to show how much bullion’s price is based on expectations of higher inflation — much, much higher. Just ask yourself the following question: What inflation expectations must already be baked into gold’s price, if inflation that is nearly double the expected increase is not enough to propel gold higher? Contrarians do believe that gold has gotten ahead of itself and needs to pull back a bit in order for the long-term trend to catch up to it. Gold’s behavior early Tuesday only bolsters that belief."

Inflation expectations are still flying against a bit of a different manifest reality, even if they are justifiable in part. Barron’s took a closer look at the latter and found that: "Though measures of reserves and the monetary base continue to expand rapidly, total bank borrowing from the Fed, in all its guises, has dropped off dramatically, falling by more than half since last spring. Perhaps still more comforting, growth in the M1 money measure has slowed. During the most recent three months, for instance, it has risen at an annual rate of only 4.9%, well within the economy’s fundamental needs, and in this more recent time, the broader M2 money measure has barely grown at all."

By mid-morning on Wednesday, the US dollar was off by 0.24 on the index, quoted at 76.68, while it slipped at tad against the European common currency as well, and quoted at 1.458. Expectations that the Fed will stand pat on rates fueled gains in commodities while denting the greenback — a quite familiar by now- trade. As mentioned, on Tuesday, the greenback climbed to a two-month high and was seen gaining against 14 of the 16 most actively traded foreign currencies out there.

Reasons for the above? Speculation that the pace of US economic recovery and growth outlook for 2010 (some opine that the US economy will record an about 4% rate of growth) will motivate the Fed to at least talk more overtly about pulling the plug on the bathtub-full of liquidity present in the system. Along with such potential moves could also come the truncation of the much talked-about carry trade in the US dollar, and the possible popping of various, in-progress, asset bubbles.

"The trade we’ve been riding might be running out of gas," said Peter Jankovskis, co-chief investment officer at Oakbrook Investments in Lisle, Illinois. "Treasury yields and the dollar are up, weighing on stocks. The strength in both PPI and industrial production suggests the Fed will start putting brakes on the economy sometime next year. That means raising interest rates and pulling out some of the stimulus." Mr. Jankovskis told Bloomberg News.

Observers over at RGE Monitorare not so convinced about the improving trends that the economic numbers continue to point towards. They note that: "Americans during the Great Depression voiced the same concerns about excess bank reserves, budget deficits, competitive devaluations and commodities speculation as they do today. Even dissenting arguments followed the same script in both eras. The eerie resemblance in the psychological and economic backdrop of the mid-1930s and 2009—both historic junctures when recovery was thought to have begun—raises concerns that the U.S. could be on the edge of a double-dip."

We close today with two topics of recent interest to the market: central banks and exchange-traded funds. Both are being seen as exerting a notable degree of importance in the psychology of the market. Provided, of course, we first dismiss unequivocal statements of a ‘new paradigm’ in the case of the former, and/or bold assertions that the latter mirror the masses having finally warmed up to gold ownership. Joe Wiesenthal, over at The Business Insiderreminds his readers that -when it comes to gold:

"Not surprisingly, governments are horrible traders. Trust us, it’s not just our government that’s inept when it comes to the market, it’s all of them — and so we shouldn’t be particularly surprised that the rash of central bank gold buying all around the world occurred in the last couple months, and not two years ago."

Bloomberg corroborates the possible sell signal in gold that the recent rash of central bank purchases may be giving: "This is late in the game to be buying gold," said Peter Morici, a professor of business at the University of Maryland in College Park and former economic adviser to the U.S. government. "Central banks are not known for their investment acumen. What it reflects is a lack of confidence in the U.S. economy and the long-term durability of the dollar as a store of value."

Switzerland changed its constitution to allow gold sales of as much as 1,300 tons and the U.K. began its sales of about 400 tons in 1999. Switzerland’s 1,300 tons is worth about $47 billion today compared with about $12 billion in 1999. The U.K. chose to sell its gold, a stack almost as big as two London taxis, in 17 auctions that ended in March 2002, investing the proceeds in dollars, euros and yen. The highest price it got was $296.50 an ounce in the final auction. That’s 74 percent less than today." So much for market timing, but as we have previously explained, such seemingly irrational trades may reflect reserve management more than the quest for tops or bottoms.

Vincent Fernando over at The Business Insider notes that:

1. While India’s huge purchase may at first seem like a sign of confidence in gold at current prices, we highlight that India historically has been a pretty bad gold investor. Even the more bullish Mr. Southwood agrees: Goldman Sachs: “Since 1994, gold as a percentage of India’s foreign exchange reserves fell from just over 20% to approximately 3.6% (based on latest reserve data of US$285.5bn on 23/10/2009).” So the Indian central bank essentially sold ahead of the massive gold rally – They missed the rally. And now they’re jumping in with a giant 200 ton buy in one fell swoop. The Indian central bank’s historical gold trading record implies that could be a potential reverse indicator, if anything.

2. The piece also highlights an excellent gold chart, shown below.
   

   What this chart essentially shows us is that since 2005, gold’s price action has changed dramatically from the 2000 – 2005 period. Shown in blue below, from 2000 – 2005 gold rose alongside a weakening dollar with a fairly stable relationship to the euro. But then in 2005 it suddenly diverged from this, and took on a rocket-like trajectory that no longer had much to do with the previous dollar/euro trend. It even seems to have simply become erratic given the dispersion in prices, shown by the black dots. If we then consider that this change below happened just around the time that Gold ETFs started to take off, then it makes sense. Thus this supports the view that gold today is driven less by ‘fundamentals’ and more by fund flows and retail speculation via ETFs. It has mutated into a speculative instrument, as shown vividly by Mr. Southwood’s excellent depiction:

All ears on the Fed. Monday’s EW call for a sharp rally in gold prices this week may yet materialize.

Jon Nadler
Senior Analyst

Kitco Metals Inc.
North America 

Check out other site market resources at Bullion Prices, Silver Coins Values and the US Inflation Calculator which easily finds how the buying power of the dollar has changed from 1913-2009.