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Autumn Leaves and Other Falling Things

By Jon Nadler       Printer Friendly Version
Oct 17 2008 4:28PM

Good Afternoon,

Gold prices lost more than 8% during this most turbulent of weeks, bringing their 30-day net change to a minus 9.1% and shrinking the 1-year net change to only 3.6% as a result of relentless fund liquidations and selling by frustrated longs. Thus ended the largest weekly loss in over two months. Friday's lows came near $770 per ounce and mild recovery attempts brought values back to near $785 on the heels of a better than $2 rise in crude oil, and a fairly 'stable' (by recent metrics) Dow. The US dollar continued a bit higher (@82.50 on the index), but momentum appears to have slowed somewhat over the past few sessions. Not so, in the downward path of the Canadian dollar (@84 cents), which remains under continuing pressure from caving commodity prices.

Bullion remains on the defensive on the back of said fund selling, of drastically trimmed inflation expectations and of the nauseating volatility in the global equity markets. In aftermarket trade, bullion was down $20 to the low $780's, while silver struggled in the low-to-mid-$9's. Silver dropped 33 cents to $9.32 per ounce. What else can be said. Platinum recovered a bit and only declined $24 to $872. Palladium fell $3 to $169 per ounce. These markets are still dealing on the basis of little more than raw emotion, and greed is conspicuously absent from the mix of fear, panic, desperation, and even capitulation, that is flooding the average institution or investor's psyche these days. Okay, there is a little greed showing in the 'Hey, look at me!' approach taken by Warren Buffet today as he tried to indirectly convince Americans that the time to buy their country's own stocks was upon them. He is not even thinking commodities at this time. It's all about US stocks and the comeback of America for Uncle Warren. Is Mr. Obama watching?

Today's US housing starts data pointed to the second lowest such number in half a century, while consumer confidence fell by the largest amount on record. Mr. McCain was only half right the other night: US consumers are angry indeed, but more than that, they are pessimistic and becoming extremely cautious on issues like spending. Could there be a referendum of sorts visible in the latest numbers? Even if there isn't, the guilt-by-association syndrome engendered by this major postwar slump is likely to do untold damage to the GOP. In the end, the party that was supposed to be all about economic freedom and trickle-down principles, ended up adopting rescue plans and policies that it could only dream about and attribute to the opposition. C'est la econo-political vie...

Significant price erosion continued in the precious metals complex today, as participants continued to unwind position for various reasons. Fund liquidation remained the name of this game, and it appears that no amount of individual investor interest has been (thus far) able to stem the declines. Alleged metal 'advisors' and certain mining company heads (what else is new?) have been trying to offer all kinds of invalid explanations not only as to why the prices of metals and related equities have been declining in the face of the most perfectly suitable event for their possible rise, but as to why they will soon be headed for various celestial bodies.

We'll give them a simple clue: there must still more sellers than buyers present in a market the prices of which are going downward. Wake up, and look it up in a basic economics textbook. "Joe the Plumber" knows that much, already. The 'disconnect' these folks see, is a reflection only of the disconnect that exists between market reality and their idealized, fantasy world. The positions that hedge funds have piled on and are now being forced to sell are something we tried to warn readers during the gung-ho days of the commodities markets. They managed to distort such markets far from their fundamentals on the way up, and the same effect might be the result once again - this time, in the opposite direction.

Any wonder then, that for the next year or two, the outlook on the niche is not particularly positive? Dark days are seen ahead for commodity demand, as we learn from a current Standard Chartered Bank research note (brought to us by Mineweb):

"Standard Chartered Bank (SCB) says the demand picture for commodities does not look supportive and it expects commodity prices to remain weak well into next year and subdued until the middle of 2009. However, secular demand growth for commodities remains intact in the longer term. The bank said in a research note that growth is slowing, not only in the OECD, but also in emerging markets, as the impact of the current financial sector crisis spread. Head of SCB's Commodity Research Helen Henton said demand for commodities is already suffering, while the bank expected further weakness in demand. Commodity supply cutbacks would help in some cases, but overall there will still be downward pressure on prices.

"With GDP growth likely to remain weak well into next year, we expect prices to remain subdued until the middle of 2009. What we are seeing is a cyclical demand downturn," said Henton.Henton added that the bank had been highlighting the risks of slower global demand for some time, but the deterioration has been accelerated by the financial crisis. But she pointed out that, in the longer term, the story of secular demand growth for commodities remained intact due to the development of key economies such as China and India.

The bank's view on base metals was that metals demand from China - key to the base metals outlook - is not collapsing, but that the pace of growth has slowed. Chinese base metals consumption has already slowed considerably in the last few months due to a combination of a slowing global economy and government attempts to rein in inflation that "squeezed" manufacturers, said SCB.Demand conditions for base metals are likely to worsen in the months ahead, but supplies are also likely to be cut back on lower prices. It was important to note that headline figures overstated the weakness, as these were distorted by a huge inventory overhang. "Once this has been worked through, demand growth will look healthier," said Henton.

SCB said anecdotal evidence supported the view that copper consumption growth has slowed sharply. Fabricated copper production fell to 18% year-on-year in the year to July from 23%, due to weaker than expected demand from a few key "end-use" sectors including home appliance, air conditioner and refrigerator manufacturers. In 2007 apparent consumption growth was at 37%, but growth dropped to an average 4% in the first eight months of 2008. However these figures were distorted by the inventory cycle. SCB said it was not all bad news for copper as the expansion of the power sector was providing solid support to copper consumption and would prevent demand from sliding in absolute terms. This came as electrical use of copper still dominated or comprised 60% of total usage.

Demand for platinum group metals (PGMs) was likely to weaken further, despite the fact that supply issues persist. This follows heavy falls in PGM prices with ongoing problems in the automotive sector adding to downward pressure.

In contrast, gold is likely to remain well-supported near term by safe haven flows and falling interest rates. However, once financial conditions stabilise, some of the safe-haven flows would disappear and together with US dollar strength, bring prices lower. But in the longer term, SCB retains its bullish outlook on "structural" US dollar weakness."

Ah, but that (bearishness) is not the case in every niche, you know. Mark Hulbert, over at Marketwatch returns with his periodic reading of the temperature among gold timers and finds...more hot (headed) bullishness. Stout bunch, the bugs. Admirable conviction levels - too bad that many do not think through the entire scenario required for mega-four-digit gold prices. Yes, the one involving .357 Magnums and such. Batting average or not, incorrect assumptions about sinister suppression notwithstanding, Mr. Hulbert's metric has been fairly successful over the past several such postings. Let's see what his thermometer says:

"The dominant feature of the economic landscape over the last month has been the eagerness of monetary authorities around the globe to throw huge amounts of money at the banking system. If you want a textbook illustration of what economics textbooks refer to as "helicopter money"-- the huge inflationary phenomenon for which Fed Chairman Ben Bernanke earned his nickname as "Helicopter Ben -- the last month would seem to be it.

Chart of GLD

And, yet, gold bullion, the ultimate inflation hedge, hit a one-month low on Thursday, falling $34.50 on Thursday lone. See story

What's going on?

Readers probably can guess my answer: I think it is in large part due to market sentiment. According to contrarian analysis, there's been an excess of bullish sentiment in recent weeks and months, in effect forming the veritable golden slope of hope that makes it easier for the market to decline than advance.

Consider the Hulbert Gold Newsletter Sentiment Index (HGNSI), which reflects the average recommended gold market exposure among a subset of the shortest-term gold-timing newsletters tracked by the Hulbert Financial Digest. As of Thursday night, the HGNSI stood at 37.9%.

To put that level in perspective, consider that the HGNSI was seven percentage points lower when I wrote my most recent column on gold sentiment (on October 5), despite gold bullion being some $25 per ounce higher. It's not an encouraging trend, according to contrarian analysis, when market timers become more bullish as the market declines. That suggests a significant amount of stubbornly-held bullishness, which is just the opposite of the kind of sentiment environment that supports sustainable rallies. See Oct. 5 column

Some of you have objected to my applying contrarian analysis to the gold market, on the grounds that it is being manipulated by the monetary authorities and therefore not a free market. This objection potentially is legitimate. However, the proof of the pudding is in the eating: Manipulated or not, the gold market performs better when the HGNSI is lower than when it is higher.

That at least is the conclusion that emerged after I submitted more than two decades of HGNSI data to rigorous econometric tests. The inverse correlation between HGNSI levels and the gold market's direction over the subsequent several months is statistically significant at the 95% confidence level.

This doesn't mean that the gold market isn't manipulated, I hasten to add. More than one factor can influence the market's direction, after all.

But the results of my econometric tests do show that government manipulation of the gold market isn't the only factor influencing bullion's price."

Absent concrete proof of malicious manipulation by those in charge, we remain divorced from the idea and continue to find much more meaningful clues to this market in the almost total abstinence manifested by Indian gold buyers in the midst of their most meaningful festival season for the metal, in the forced liquidations among funds that made bad guesses, and in the realization that the immediate worry factor has the 'De" prefix affixed to the root "flation" If one wishes to deny those factors and put a bullish face on to their justifiably angry subscribers, so be it. Looks like Mr. Hulbert might receive some irate e-mails.

As the three grand jury probes on the Lehman failure begin, we will leave you with this Q&A for a change:

- What's the difference between a Lehman Bros. trader and a pigeon?

- A pigeon can still make a deposit on a Ferrari.

Happy Weekend. The leaves are turning. Go out and observe the transitory nature of...everything.

Jon Nadler

Senior Analyst
Kitco Bullion Dealers Montreal



Disclaimer: The views expressed in this article are those of the author and may not reflect those of Kitco Inc. The author has made every effort to ensure accuracy of information provided; however, neither Kitco Inc. nor the author can guarantee such accuracy. This article is strictly for informational purposes only. It is not a solicitation to make any exchange in precious metal products, commodities, securities or other financial instruments. Kitco Inc. and the author of this article do not accept culpability for losses and/ or damages arising from the use of this publication.