In the Lead – Bubble, Bubble On the Wall


Bullion BarsGold and other precious metals prices fell as the new trading week got underway in New York this morning and the principal culprit for the decline was identified as the rising US dollar by polled traders.

This is not to say that there were no other factors that came into the equation to help commodities values move to lower ground this morning. Chief among the "extras" was the fact that a survey focusing on the Chinese purchasing managers’ index for the current month — conducted by HSBC — indicates that the official figures from the country may indeed reveal that manufacturing activity in May has slowed to a 10-month low.

Adding to apprehensions related to China’s slowing down were perceptions that despite the indications that momentum is indeed slowing in the Chinese economy, the PBOC will stay the course with its tightening policy for the foreseeable future and that such a stance might further dampen consumption of "stuff." Such "stuff" as crude oil, for example, lost more than $3.25 this morning in New York as traders sold the…stuffing out of it and drove it to $96.83 per barrel.

Speculators in black gold cited the Chinese manufacturing thermometer’s reading and the fear that Europe might slow down as well as their reasons for lightening up on positions. Of late, of course, as oil has gone (and as the dollar too, in the opposite direction) so did the yellow metal. This, despite European debt-related angst, which continues to be manifest at present, and has been boosted by the fresh cut in Italy’s credit ratings courtesy of Standard & Poor’s Ratings Services that took place late last week.

As the euro swooned in the wake of such bleak perspectives, the US dollar sailed higher and dented commodities once again. The greenback was last seen trading at 76.35 on the trade-weighted index, rising 0.75% as alternatives still appear to be on the scarce side for safe-haven seekers. The counter-cyclicality of gold and the dollar thus resumed for the time being and the two went their separate ways this morning. Upcoming options expiry and month-end book-squaring ahead of the US long holiday weekend will keep the action on the boil this week, no doubt.

The so-called "5 Minute Wrap-up" over at India’s Equitymaster site questions whether the shake-up in speculative fever might be the catalyst to bring this cycle to an end.

The analysis notes that "commodity prices – be it food or non food – have assumed a disproportionate weighting in government and central bank policy making (especially so, in the past 18 months). During this time they have also emerged as a very lucrative investment. The meteoric rise in prices of precious metals like gold and silver, resources like oil as also some food crops has confirmed this belief. Most analysts and investors recognize the fact that commodities by nature are cyclical. Hence the rise in their prices cannot last forever."

While Equitymaster points out that speculative activity was an obvious catalyst for the recent gains in gold and especially in silver, it also notes that the inverse can certainly be true when it comes to crashes such as the one recently witnessed in…silver. The advice to investors by the Equitymaster analysis is that they are "better off not getting carried away with the greed of riding the commodity bubble." The article also singles out iron ore at this juncture. Here is a commodity about which China’s biggest steelmaker has been quoted on Bloomberg as saying that its prices are "near bubble level."

The "B" word has been making the rounds quite frequently since the start of 2011 in certain niches; that is for sure. As to how many of how few recognize a spherical object of that type when they see one (let alone when they actively participate in one), well, that is a story for another day. Suffice it to say that, historically speaking, the recognition of a balloon is normally applied in retrospect and that the popping of same never occurs in a slow-motion manner.

New York spot gold dealings started the day with a loss of from $6 to $8 per ounce and while they traded above the $1,505.00 level and as high as $1514 overnight the nervousness remains tangible as other parts of the metals’ complex suffered thrice the damage in the wake of economic-flavored jitters being displayed by the specs. Silver fell 58 cents to the $34.50 mark and remained under pressure once again while the CME flat-out asserted that it was not responsible for bursting the bubble that had clearly formed by the last trading day of April.

The platinum-group metals dropped by fairly sizeable amounts this morning as players in that niche also found it wiser to let go of positions rather than build on some of last week’s hard-fought gains. Platinum fell $29 to start off the session at $1,745.00 the ounce, while palladium lost $11 to ease to the $722.00 per ounce level. Rhodium also continued weaker, trading at $1,890.00 and exhibiting a $10 per ounce decline in the quotes we obtained from New York traders. Not much in the way of specific news from the automotive sector was available at this early stage of the weekly trade, but the complex was basically seen following the larger-than-3% decline in crude oil and was also seen as worried about Asian and European future demand as economic conditions came into question.

Another factor that likely played into the weakness on display in the commodities niche this morning was the fact that CFTC data revealed that players in agricultural commodities have scaled back their bullish positions (in some cases by hefty percentages) in the wake of perceptions that the recent advent of stratospheric food prices has caused a sufficient amount of demand destruction in the niche to result in a palpable easing of whatever shortages were thought to be present in the markets. Wheat’s net-long positions shrank by 54% in the latest reporting week (ended May 17th) while cocoa positions were seen contracting by 39%. Similar 30% + declines in net-long positions also took place in lean hogs and coffee. Chocolate lovers, rejoice. Caffeine junkies, party on.

Meanwhile, Fed-watching addicts, well, keep on watching. Bloomberg notes that the "cue" for the US central bank to begin its "mopping-up" of the monetary stimulus campaign may actually be inflation; not as seen and felt on the street, but inflation-related expectations. Such anticipation has leaped by more than 43 percent since the start of what has become known as the QE2 that was set into motion last November.

The jump in the metric of what is expected down the road versus what is tangible at present is now sufficiently large to serve as that "green light" that the Fed needs in order to set the monetary policy’s course towards the "Exit" sign.

Or, as former Richmond Fed President Alfred Broaddus puts it "this is one of those really critical turning points in monetary policy where it’s pretty clear the next move is toward tightness, and the whole question is timing."

Then again, especially in the markets, timing is…everything. While the recent exit by George Soros from his gold positions has only served to sharpen the debate about whether or not gold was/is in a bubble (and not only because the man called it the "ultimate bubble" in Davos this winter). The pro-bubble theorists point to signs ranging from the recent "adoption" of metals by Utah to serve as legal tender means to the launch of Ayn Rand-based film "Atlas Shrugged" as unmistakable evidence that the party is now in its hangover phase. Anti-bubble proponents continue to argue that until the last man, woman, and child in America (and the rest of the world) is seen standing in line to buy a gold or silver Eagle, there is no need to fret.

The Financial Times Lex team has something to say on the matter as well. On Sunday, the FT posted an article which basically concludes that it is "foolhardy" to predict the top of the gold bubble, but that it is much safer to predict that the popping of same will be "especially nasty." The article decimates currently fashionable urban myths circulating heavily in various gold forums as regards the absence of gold from the backing of ETFs, and as regards vast gold-related conspiracies.

The Financial Times, in what is sure to be labeled as a "hit piece on gold" by certain camps, notes that gold "ETFs, led by the enormous SPDRS Gold Trust (GLD), today own about 2,000 tonnes of the stuff (equivalent to a quarter of US government official reserves). A loss in the popularity for the whole ETF concept of vicarious holding of the precious metal — the World Gold Council just reported rare outflows in the first quarter — could create much more pressure than is normal for an investment that loses buying momentum. Why? Because the virtuous cycle of lowering barriers to entry for gold investing through innovations such as GLD would work in reverse. The ETF’s physical bullion (remember, it exists) would be dumped on to a market made up of a smaller group of investors, those willing and able to hold physical gold."

We have repeatedly suggested that while the gold ETFs have signified "manna from Heaven" for gold producers and for gold prices, the mere turn of the market towards a sideways-trending pattern (G*d forbid a full-on bear market) could result in the physical markets being swamped by several hundred tonnes of the yellow metal.

As the FT puts it, "If just half the gold held in trust for ETFs were sold over three years, the amount available for bar and coin investors would increase by 50 per cent, based on their average demand of the past five years — and by 100 per cent based on the pre-bull market level of demand. There should be no big problems for the ETFs and their market-makers; they could operate safely in liquidation mode. And physical buyers could be found to absorb the additional supply from the ETFs — at some price. But to clear the market, it is likely that the price would have to fall."

While one might strongly disagree (and likely be vindicated) about the prospects of half of the ETF gold hitting the markets any time soon and wreaking such havoc on prices, it is certainly worth pondering what the effects of a mere 10 or 20 percent gold outflow from the instruments might be. Consider the hoopla that resulted in the wake of the RBI’s "purchase" (more like a charitable gesture to the IMF when it was rather desperate to find a home for it) of 200 tonnes of gold not that long ago. Double that amount and you might have the beginnings of some kind of "news" storm and a whole lot more…

Until tomorrow,

Jon Nadler
Senior Analyst

Kitco Metals Inc.
North America and

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