In the Lead – Pop-Pop, Fizz-Fizz…


Bullion BarsThe month of May was not very kind to the commodities’ sector, as it is beginning to now become clear. The longest bull-run in the asset class since the heady days of 1980 was truncated by a drop of more than 7 percent in the S&P Goldman Sachs Continuous Commodity Index of 24 raw materials. Silver prices led the decline towards lower levels, however a host of other commodities also experienced large-scale sell-offs as funds exited the hitherto rather "frothy" niche.

The white metal fell by 21 percent on the month, in brick-like freefall on the charts from its $50+ record high; a level that had also not seen since "Another Brick In The Wall" topped the music charts in that certain year. Yesterday, UBS analysts offered the opinion that silver might revisit price territory that lies under the $30 area as its gains cannot be "sustained by industrial demand." Behind all of this, at the end of the day (make that; month), lies the better than 2.2% gain that the beleaguered US dollar recorded during the past 31 days. It’s almost that simple of a cause-effect explanation.

The new, abbreviated trading week got off to a bit of a mixed start in the precious metals’ complex. Gold fell $4.00 on the open and was quoted at $1,535.10 the troy ounce. Highs near $1,541 were recorded during the overnight trading hours and the yellow metal continues to offer the possibility of a renewed test of the $1,545 – $1,550 area provided crude oil and the dollar behave as seen in the early part of this morning’s action in New York. Crude oil not only shrugged off Saudi "calls" for $70 – $80 oil based on  potentially "losing" some big "customers" (say, Europe?) to the triple-digit values we are currently witnessing, but it roared ahead with a $2.68 per barrel gain and it climbed to $103.27 this morning.

Silver added 38 cents this morning and it opened at $38.45 while also showing a tendency to possibly re-test the $39.00+ resistance area if speculators amass the courage to do so. The stellar performance of the morning however came from the noble metals’ niche. Rhodium stole the "show" with a near-8% rise that brought it to $2,300 on the bid-side, in short order. Platinum gained 1.78% while palladium rocketed nearly 3% higher. The former traded at $1,827.00 per ounce while the latter climbed to $774.00 per troy ounce on account of the largest shortfall in nearly thirty years being noted by Standard Bank Plc.

The bank projected a 1.6 million ounce deficit in the palladium market for the current year. In the background, news that BMW AG sold a record number of cars in Q1 and that Nissan expects 2011 to be its best sales year ever, only added to the bullish tilt in the noble metal. Palladium has thus far lagged gold, silver and platinum in terms of year-to-date performance after having led the pack in terms of same last year (it doubled in value while everyone was hypnotized by silver’s speculation-based climb).

Also helping matters for the performance in the platinum-group metals’ space this morning was the news from Japan that the country’s industrial output managed a post-quake rebound of 1% just weeks after the horrific event which prompted many a doomsday-oriented subscription-based publication to unequivocally declare the "end" of Japan and envision a decades-long recovery, if any at all.

The quicker-than-anticipated resurgence of overall Japanese factory output encouraged automotive analysts to shine a very positive light on the sector as of this morning. Car production ranks as one of the pivotal pillars of the Japanese economy’s manufacturing sector. That said, there are a number of automotive analysts who do not expect US car sales to be very worthy of praise for the months of April and May, as the effects of the Japanese quake became manifest in the marketplace in North America. actually expects a small dip in US car sales from levels recorded one year ago.

The other news item that appeared to be playing favorably this morning into the gains shown by the Dow for example, as well as by commodities, was the one surrounding the possibility of further aid to Greece being offered by the EU. Stories are circulating that Germany may drop its demands for a rescheduling of Greek debt and that such a shift may open the door to further assistance to the fiscally-stressed nation. In any case, the decision on any additional aid to Greece by the EU will come by the end of June. Thus, the end of June is shaping up to be a pivotal time for markets in more ways than one. See below.

To what extent May’s downturn in commodities will eventually come to be regarded as a mere correction in a still-intact uptrend or the start of a "different" phase in the broader commodity cycle, well, that might become more clear with the benefit of a few additional months’ worth of hindsight. Boston-based GMO fund manager Jeremy Grantham sees the next couple of years as potentially posing a significant risk to commodity valuations due to any possible "surprises" in either Chinese growth, global weather, and, of course the expiration of QE2. Such sobering caution comes in the wake of certain valuations in certain commodities that have not been seen at such levels in a couple of…centuries (!).

For the time being however, a few things are fairly worthy of watching with care. The first is the fact that the US dollar is fast-approaching, or is perhaps already at, a significant inflection point on the index chart. If the positioning of the speculative trade is any indication of where currency players might be seeing the dollar as being headed, then we might take into account the fact that bearish bets on the greenback have now been pared back to a level not seen since last December. The CFTC’s trade positioning data as of May 24th reveals that pro-dollar bets are on the rise while the opposite are shrinking in the wake of the problems that have affected the euro.

Currency traders and speculators are also apparently not anticipating further major declines in the US currency against the yen, the Swiss franc, and the Canadian dollar. If perceptions that the global economic recovery is hitting a mid-cycle "air-pocket" are correct, then the "risk-on" trade might experience a decline in popularity that might help lift the greenback quite nicely from its early May paradigm where everyone and their cousin was massively shorting it. It could be that the bears might hibernate during the summer, for a change.

The other watch-list item is the fact that with the cessation of the Fed’s QE2 program the scrutiny will become very intense on the US central bank’s monetary policy going into the second half of 2011. While many other central banks around the world have already embarked on the path to tightening, the Fed has remained in an accommodative stance thus far. Much of what the greenback does or does not do following the advent of the year’s second half depends precisely on what the Fed might or might not do policy-wise. Either way, we have another pivot-point in the making.

The long weekend gave the opportunity for some financially-oriented bloggers to reexamine the idea of bubbles and what makes them tick. Fundweb’s Vanessa Drucker made just such observations in a piece titled "Fizzy Assets" and dissected the dynamics of these spherical weapons of wealth destruction (that is, when they implode). Ms. Drucker opines that the "key" narrative which enables a bubble to expand may take various forms. These may range from a scare (such as the one that says that the world is on a Malthusian path of peak oil or agricultural products) to a promise of salvation (the dollar and other fiat currencies are doomed, so only hard assets like gold will retain value) to a "seductive" or "New Era" declaration (like the one that saw the Internet as a paradigm shift of "immeasurable proportions").

Three investment and psychologically-based fallacies play into this sad reality: the "hot-hand" belief that a trend is endless, the aversion to losses and loss of social status by not participating in a "hot asset" and the leanings towards confirmation bias. That is when any information that contradicts one’s world view is overlooked, or ridiculed. Finally, no one should ignore the damaging role that being overconfident can play in remaining in a bubble far longer than is safe. One suggestion that, for example, Max Dufour (Sungard Global Services) offers is for investors to consider setting "stops" at about 7% under the level at which they enter a hot market in order to avoid the possible wipeouts that will most certainly affect others when things deflate.

Until tomorrow, gamble with…care.

Jon Nadler
Senior Analyst

Kitco Metals Inc.
North America and

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