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Suspicion is NOT Substantiation

By Jon Nadler       Printer Friendly Version
May 30 2008 2:42PM

Good Afternoon,

Gold prices staged a recovery of just above 1% rising to near $890 on Friday, as flat lining consumer spending numbers took a bite out of the dollar's rally on the week and sent it back to just under 73 on the index. Crude oil picked up half a dollar, rising to just above $127 and the combination aided gold recoup some of the week's steep losses. At the end of the day, the metal will still close the week out with a loss of about 4.5% in the wake of the oil correction / dollar rally background. While data released today shows that inflation eased, it also obviated income gains for the average American.

Consumer spending edged up, but continued to show caution, while consumer sentiment sank to its lowest level in 28 years. Despite all of this, the odds makers are tabulating a 0 percent chance of rate hikes for the Fed meeting in June, while the October projections are calling for interest rates being raised by a 54% majority. Turns out that the recession may be as shallow and as brief as some of the more optimistic analysts have been calling for. The threat remains in the advent of a consumer recession due to the share of the economy that wallet-flexing by mall dwellers represents.

New York spot trading maintained a gain for most of the final session of this week, and was last quoted at $887.00 per ounce, up $10 on the day. After two consecutive months of net losses, the yellow metal faltered towards the end of this one as well, but managed to eke out a slim 1% or thereabouts gain in the spot price over 30 days. Good thing this was not yesterday's tally. For the moment, oil prices are still calling the shots, as they have all week long. Silver rose 25 cents to $16.85 while the noble metals added to their respective values, with platinum rising $10 at $2009 and palladium gaining $11 at $437 per ounce. As noted yesterday, this was an expected session of repair work, but the liquidation clouds have not yet dissipated after the week's rout.

Let us now take a look at...drum roll....speculation and manipulation - favorite topics for many. Oil's recent meteoric rise has given everyone plenty of opportunity to come up with wild theories as to who is responsible, and how such a trajectory was achieved. Certainly, the Fed-induced decline in the dollar has given plenty of speculators plenty of reasons to seek refuge in various commodities.

My good friend, Paul van Eeden, was recently interviewed on CNBC as regards the causes of what has driven crude oil to such lofty levels. Here is what he had to say:

Much like in the gold market, allegations of manipulation and a proliferation of conspiracy theories have been the hallmark of the commodity of late. Much like in the gold market, at the end of the day no one has been able to prove that such nefarious activities are real. Much like in the gold market, the available evidence as to why prices move (and sometimes with great force) only points to hedge funds and their ilk when it comes to finding what/who is behind the scene. A quick glance at a news poll reveals that the public is convinced that oil is being manipulated. However, Business Week's Moira Herbst reports:

" Speculation. Manipulation. As politicians, business leaders, and ordinary consumers try to grasp the causes and effects of the historic surge in oil prices, attention turns to dark notions of exploitative financial maneuvering.

Are savvy traders cashing in—or even cornering some portion of the market—and thereby contributing to the painful runup that's shaking everyone from airlines to commuters at the gas pump?

Sounding a populist note on the Presidential campaign trail, Senator Hillary Clinton (D-N.Y.) has called for "cracking down on speculation by energy traders and market manipulation in oil and gas markets." Exxon Mobil Senior Vice-President J. Stephen Simon, trying to deflect criticism of oil company profits, told a Senate panel on May 21 that speculation, along with geopolitical instability and a weak dollar, have created a "disconnect" between past price patterns and the current gusher to $131 a barrel. Motivated by a similar desire to direct outrage elsewhere, OPEC Secretary General Abdalla El-Badri also has stressed the role of traders in driving prices higher.

When oil jumps as much as it has, doubling since May, 2007, it's natural to assume that something striking must have changed. Some say the world is running out of the stuff; others blame market manipulation. The search for a culprit is understandable.

But persuasive evidence of manipulation by traders is, so far, lacking. Speculation—placing bets on future prices—is another matter. There's plenty of that, and it's generally legal. In fact, there's a good argument, if not conclusive proof, that sharply escalated trading in oil futures has contributed to price increases. But it's important to remember that the nature of the oil market—specifically, the extreme inflexibility in both supply and demand—is amplifying whatever influence traders exert on prices.

For there to be real manipulation, financiers somewhere would have to hold substantial amounts of oil off the market, planning to unload it in the future. Jeff Bingaman (D-N.M.), chairman of the Senate Energy Committee, has suggested that a recent trend of institutional investors acquiring oil storage capacity creates "concerns regarding potential market manipulation strategies." In a letter on May 27, he scolded officials with the Commodity Futures Trading Commission for "glaringly incomplete" testimony during recent hearings on oil speculation. He demanded more information about how the agency tracks trading.

But suspicion isn't the same as substantiation. To date, no one has pointed to particular examples of hoarding. CFTC experts testified that market forces are driving prices. The agency says it's working on a response to Bingaman's letter.

What can be corroborated is vastly increased trading levels as hedge funds, investment banks, pension funds, and other professional investors have poured money into oil and other commodities, seeking a hedge against inflation and alternatives to a shaky stock market. In the past five years investment in index funds tied to commodities has grown from $13 billion to $260 billion. More than 630 energy hedge funds are placing bets, up from just 180 in 2004, according to Peter C. Fusaro, founder of the Energy Hedge Fund Center, a trading information Web site.

Futures contract traders on the Intercontinental Exchange made bets on oil with a total paper value of $8 trillion in 2007, up from $1.7 trillion in 2005, according to U.S. Securities & Exchange Commission filings. Over the same period the volume of futures contracts traded on the New York Mercantile Exchange more than doubled, although dollar figures aren't available. The over-the-counter market is even larger but difficult to measure.

With energy demand in China escalating and world supplies static, the influx of money has helped chase prices higher. "The hedge funds and speculators have run it up way beyond where it should be," says Malcolm M. Turner, chairman of Turner, Mason & Co., a refining consulting firm in Dallas.

In most markets, skyrocketing prices would result in increased supply and decreased demand. That would cause prices to ease. But the oil market isn't working that way. Supply is essentially fixed in the short term because it takes years to find new fields and bring them online. Demand, meanwhile, is also essentially fixed, since there is no ready substitute for gasoline, diesel, and jet fuel. Flush with cash from investors of all stripes, traders observing these conditions have bid prices up and up.

It's hard to calibrate the influence of speculation because most of the oil market is unregulated. That murkiness almost guarantees that conspiracy theories will continue to proliferate."

In the meantime, Mark Hulbert continues to wring his hands about the stubborn bullishness among gold timers. For the second time this week, Markewatch's observer of contrarians and gold timers rings the alarm bell based on what he sees:

" I noted earlier this week that gold-timing newsletters were being strangely jubilant in the face of weakness in gold's price, and that according to contrarian analysis this was a bad omen.

Right-click here to download pictures. To help protect your privacy, Outlook prevented automatic download of this picture from the Internet. Chart of GLD

Believe it or not, I can say nearly the same thing now, despite two more days of steep drops in the price of gold bullion.

Take recent readings of the Hulbert Gold Newsletter Sentiment Index (HGNSI), which reflects the recommended gold-market exposure among a subset of short-term gold-timing newsletters tracked by the Hulbert Financial Digest. As of Thursday night, the HGNSI stood at 33.2%, exactly where it stood seven trading sessions previously--despite gold dropping over this period from $933.20 per ounce to $881.20. (These prices are from the August COMEX gold futures contract for August delivery.) In other words, the average gold timer is not treating a decline of over $50 as any reason to reduce his recommended gold exposure.

That's unusual, and very worrisome from the point of view of gold's shorter-term prospects. Normally, gold timers reduce exposure when bullion declines, and when they don't it means they are stubbornly resisting the notion that the decline has much further to go. As contrarians like to say, bear markets like to descend a slope of hope. And what we're seeing among gold timers right now has all the hallmarks of exactly that.

What would it take to persuade contrarians to once again be positive about the yellow metal?

By way of an answer, consider the sentiment that prevailed in early May in the gold market. At that time gold bullion was trading more or less at the same level it is today. And yet the HGNSI at that time stood at minus 10.7%, meaning that the average gold timer was recommending that his clients allocate 10.7% of their gold portfolios to going short -- an aggressive bet that gold bullion would continue to decline. As I pointed out in a column at the time that appeared in Barron's On Line, that pessimism boded well for gold bullion. And, just as contrarians were expecting, bullion did rally smartly over the next couple of weeks.

The sentiment situation that prevails today couldn't be much more different. Until the average gold timer throws in the towel and begins betting that gold is sure to go lower, contrarians will continue to tread cautiously. That might come sooner than you think. The consensus mood among gold timers has been shifting with dizzying speed in recent weeks. So stay tuned."

Indeed, staying tuned (but not necessarily jumping in) may be the theme as we begin June's price gyrations. A recapture of the $890/$900 prize might be very nice at this juncture, (as would a rally to $915) but much depends on black gold and the greenback as far as the yellow metal is concerned. Internal factors are still scarce and bullish news largely absent from the scene. Support is seen at $870 and will hopefully hold, however the $845/859 zone is still the potential lower target of this latest decline.

Happy Trading. Pleasant Weekend.

Jon Nadler
Senior Analyst
Kitco Bullion Dealers Montreal



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