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More gains ahead of the Fed could mean more risk for the longs

Commentaries & Views

OUTSIDE MARKET DEVELOPMENTS: Global stock markets overnight were mostly higher with the exceptions of the Shanghai markets and the FTSE 100. Gains were less than 0.25% for the most part, except Australia which was up 1.1%. Global economic data revealed significant declines in Japanese imports and exports for the month of August relative to year ago levels, a significantly stronger than expected UK core consumer price index relative to a year ago, softer than expected UK producer price readings, and a larger than expected EU trade surplus for July. The North American session will start out with a weekly private survey of mortgage applications, followed by August retail sales, which are expected to have a modest downtick from July's 1.2% reading. The August Canadian CPI is forecast to have a modest uptick from July's 0.1% year-over-year rate. July US business inventories are expected to have a sizable uptick from June's -1.1% reading. The September NAHB housing index is forecast to hold steady with August's 78 reading. Early afternoon in the US will see the results of the latest Federal Open Market Committee (FOMC) meeting, which is not expected to show any changes to rates or policy. However, updated FOMC economic forecasts (the "dot plot") and the post-meeting FOMC comments by Fed Chair Powell will be heavily scrutinized for clues on upcoming Fed policy moves. The latest Treasury International Capital (TIC) report will be released late in the day and will be scrutinized for net changes to Chinese and Japanese Treasury holdings.

GOLD / SILVER

Apparently a slightly lower dollar, ongoing optimism from equities and higher oil prices has provided a positive initial start to the Wednesday gold and silver trade. However, it is possible the bull camp in gold and silver could be disappointed by the outcome of the FOMC meeting this afternoon. A moderate portion of the trade now thinks the Fed will present a slightly "improved" economic forecast and will once again reiterate its promise to hold rates down for as long as is needed to work toward its full employment objective. While the gold and silver trade are not rife with expectations for actual Fed "action," status quo with a slight improvement in economic views should present some selling in the late afternoon trade. It is possible but unlikely that the Fed could announce its intention to step up bond buying or indicate its desire to implement what it has called "creative new policy tools," and that would result in a definitive spike up move in gold and silver. We think Fed action is less likely given the increased potential for a surprise fiscal stimulus agreement, as that would allow the Fed to conserve ammunition with Congress doing some of the heavy lifting. While the headlines over the last 48 hours have touted a significant slowing in investment demand for gold ETFs, yesterday they posted their second straight day of inflows, bringing their net purchases for the year back up to 26.8 million ounces. Extensive press coverage of massive outflows from the giant SPDR gold shares (GLD) ETF are not to be ignored, as investors have pulled $75 billion from the fund over the last three weeks, ending an eight-month pattern of inflows. Countervailing the view that investors are liquidating gold ETFs is the fact that "TOTAL" gold derivative holdings continued a dominating pattern of inflows until just eight days ago, which means the outflow from GLD ETF holdings was heavily mitigated by other fund inflows. The I-Shares gold trust (IAU) has seen at 25 straight weeks of inflows! Traders should brace for a significant volatility event today, with gold prices vulnerable as a result of their bounce off last week's lows and from the inability to see consistent declines in the dollar. In a similar reaction, silver forged a multi-day upside breakout yesterday and promptly fell back from that high in a fashion that suggests the bull camp lacks resolve with the current fundamental setup. Volume remained muted on the rally yesterday, and that suggests buyers are poised to jump into positions from the sidelines. Like the gold market, silver is also likely to face increased volatility today, with the lack of actual movement by the Fed likely to send prices quickly back toward last week's consolidation low. Added liquidation pressure on silver is seen from an extending pattern of daily ETF liquidation.

PGM

The big range up extension and multi month high move yesterday in palladium enhanced the bullish setup, but we suspect that positive economic psychology, higher global equities, and positive Chinese economic data will be required daily for palladium prices to continue to rise and to regain the $2500 level. With China setting its currency fix higher overnight and the dollar showing recent signs of returning to a downtrend, it is possible that the Chinese economy has managed to get up on its skis from the shutdown and that auto catalyst demand for palladium will begin to improve. Clearly there is mounting evidence that the Chinese economy is becoming self-perpetuating, especially after news yesterday that Chinese retail sales saw a jump in jewelry and auto sales. Not surprisingly, palladium ETF inflows remain inconsequential, with investors simply tuned into that alternative investment. However with a big range up extension and the highest price in palladium since the March panic (generated by the US lockdown), it is apparent that something has changed in the palladium market. In the end, impressive action on the palladium chart, an increase in trading volume, and improving views toward China could set the stage for trade above $2,500 today. Not to be left out, the platinum market broke out up yesterday and has extended the push higher early today with the $1,000 level the next critical psychological pivot point. While not as direct an impact, we suspect favorable Chinese data helps to improve demand expectations for platinum, especially with the prospect of increased Chinese jewelry demand. Furthermore, with sharp rise in palladium prices could accelerate recent talk that platinum is regaining market share from palladium in the manufacturing of electronic products that use glass. In the event of further "risk on" psychology from equities and a positive vibe ahead of the Fed, it is possible that the January platinum contract will retest the August high up at $1,036.20.

MARKET IDEAS: Today appears to be a critical junction for gold and silver, and we suspect that a better Fed economic view without action could spark temporary disappointment given the downshift in views toward investment demand. The bull camp looks to maintain an edge ahead the FOMC meeting statement, but we suspect to see some selling afterward before gold and silver find support from "extremely dovish" talk. Furthermore, the downside action in the dollar so far this week does not appear to be indicative of a resumption of a large slide, which could leave the gold market without a dominating bullish theme. However, for many bulls this is the moment they have been waiting for, and it is possible that today's news will result in December gold prices spiking toward the 2020 high. Given the potential volatility surge, those wishing to maintain a long-term position in gold should consider the purchase of puts as a cushion against today's action. Critical pivot point support in the December gold contract today is seen at $1,944. A similar outlook for silver is seen with the potential for a big rally if the Fed actually "takes action." On the other hand, in the event that the Fed simply maintains recent "company line" statements, we suspect that December silver will fail at key support of $26.72.

COPPER

The bias is up but risk and reward for the bulls is suspect.

The mantra of strengthening in the Chinese economy goes hand-in-hand with expectations for improved Chinese copper demand, and the overnight headlines have added to that bullish condition. In addition to news that Chinese August refined copper output increased by 9.7% versus year ago levels, the trade also saw news that Chinese domestic air travel has returned to "normal." While not a reliable bullish development, it should be noted that China has begun to inoculate thousands with its vaccine, despite the fact that trials have not been fully concluded. In other supportive developments China raised its fix on its currency, and talk about buyout offers for Freeport sends a signal that copper assets are still thought to be undervalued. On the other hand, LME copper warehouse stocks seem to have abandoned their pattern of daily declines, and we are not convinced the takeaway from the Fed today will be supportive to copper. Going forward, the copper market should draft lift from headlines touting record Chinese aluminum and steel production, as well as significant gains in zinc prices. Furthermore, the London metal exchange noted a significant outward movement of zinc from warehouses, which indicates strong Chinese demand or improved global demand. We have noted several times this week the spec and fund net long position in copper is likely near record levels, so a sudden shift negative in global economic psychology could result in a large number of longs rushing to the sidelines.

MARKET IDEAS: While we favor the bullish track in copper directly ahead and would not be surprised to see new contract highs, we advise against implementing fresh long positions so far above the recent consolidation lows. Those entering long positions at current levels probably need to risk their positions to at least $2.97.

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