Gold Went Down, But Is Not Out
Philip Gotthelf
Just as I decided to re-enter the long side of gold, the market suffered a substantial technical setback.
November 17 tested below December gold's 392 technical support in an attempt to shake out weak players. The hit initially worked. However, it was to be expected based upon the temporary overbought condition that was apparent when $400 continued offering strong resistance.
If you believe in conspiracy (as so many gold bugs do), gold's upward trek has been tainted by excessive volatility around the moving averages as illustrated by the trendline. From July through August, prices rode the
tops of converging averages to keep speculators hopping in and out despite a solid upward movement. The 40-day average remained the most effective, but it was bounced with the October and November corrections.
Most analysis has concentrated on dollar parity deterioration. As goes the dollar, so goes gold in the opposite direction. I fell victim to the dollar's failed rally when we bought the dollar index while buying the Aussie and
Canadian Dollars. The chart tells the story of how the December Dollar Index was prevented from filling the gap above 94.75 by 94.50 resistance.
The collapse from the upward flag was far from a definitive signal since it appeared more likely we would see a continuation to 95.20 to fill the gap. The dollar exhausted. Trade deficits widened and a new spat with China dealt a blow to farm prices and prospects for a big pop in farm export revenue.
Overall, damage was held to a minimum by favorable entries and close stops. It was a frustrating experience because our call was right while the implementation was targeted by the cosmos!
We held on to our long Canada and must make a decision whether there is more downside for the dollar. Proponents of the interest rate relationship point out that the 30-year bond broke out above 110...more reason for the dollar to decline with falling U.S. interest rates. However, the long bond is consolidating and could easily retrace to test 109.15 support. This is desirable since we have the 105/110 put/call short strangle.
The 4-day consolidation in December T-bonds suggests 111.15 resistance will hold. Frankly, al the positive economic news should have a negative impact upon bonds as the Fed's resolve to keep rates low may be diluted by better-than-expected corporate performances.
In the wings are terrorist threats that, once again, target the U.S. retailers. Intelligence is on high alert for any plots to disrupt mall shopping with a homicide bombing. We should not be lured into a false sense of security because "it hasn't happened, yet." The problem facing terrorists is that their home bases rely too heavily upon western economic success. If you take out your customers in the name of Islam, you take out yourself...economically speaking.
Certainly, the CRB also plays a role in any decision by the Fed to keep rates low. This has gold bugs excited. They see inflation...even if the current administration does not!
Is Platinum The Metal?
The platinum breakfast was held at 8:00 am on Tuesday, November 18. This biannual event provides an interim report on the platinum group metals with a primary focus upon platinum and palladium. The forecast was for continuing deficits in platinum and a price between $700 and $820 over the next six months. While wide in range, the $700 presumed floor provides a substantial platform for this metal. My suggestion...buy platinum producer stocks, but avoid Stillwater for now. In South Africa you have Anglo Platinum, Impala, and Lonmin. If you're looking for cheap, try the Canadian North American Palladium that is benefiting from the higher platinum price and increasing palladium production.
According to Johnson Matthey, platinum demand will continue exceeding supply through 2003 and into 2004. However, this differential is forecasted to narrow to 480,000 ounces from the former 500,000+. While the deficit may be shrinking, platinum usage is destined to increase as Europe pursues low emission diesel technology and Japan mandated retrofits for heavy duty diesel (HDD) trucks in an effort to bring down pollution and enhance urban air quality.
This same program is being enforced in Western Europe and China is getting an early start at tackling prospective pollution problems with mandated low emission standards. With initial auto sales firming during the last quarter and continuing low interest rates with high buyer incentives, demand for platinum is slated to edge up by 1/2% to 6.59 million ounces for the 2003 trading year.
As mentioned in my book, The New Precious Metals Market "McGraw Hill," the balance between platinum group supplies and demand is extremely tight. This is why these metals are so vulnerable to economic dislocations associated with either supply disruptions or, in the present case, increasing demand. The book explains this delicate balance and, in fact, predicted the very situations we are currently seeing as platinum reaches prices not seen since the "go-go" years of 1979/80.
Metals traders have noticed an interesting pattern over the past five years beginning with the more obscure palladium that reached an all-time high of $1,075.00 per ounce on a Russian supply squeeze. This rocket ride to stratosphere levels was a wake up call that precious metals, and in particular, industrial metals were on the move.
The strategic values of the platinum group cannot be overemphasized. Essentially, the industrial world is held hostage to two elements with annual production rates under 7 million ounces. I do not use the word "hostage" lightly because the entire global air quality paradigm is based upon platinum and palladium catalytic converters. Without these metals, automotive technology would require total revision. It is something that could not be accomplished within any reasonable time frame.
By example, the automotive industry was just beginning to enjoy the parity differential between palladium and platinum after introducing palladium loadings into the car market. Suddenly, palladium blasts to $1,075 to reverse the entire parity advantages enjoyed by the switch away from platinum. The response was rapid...move back to the old technology. And as Murphy's Law would have it, platinum is on the rise relative to palladium.
Alas, I was unable to get the word out about platinum's potential move toward $800 immediately upon the announcement at the platinum breakfast. The fundamental reaction was a $19 boost in price. Traders are waiting because $19 is considerable and not everyone believes the price can breakout above $800. Of course, no one believe palladium could push beyond $400, let alone $1,000!
The "wild car" and underlying fear is that speculative interests will take control of platinum above $800. Although U.S. options on this metal aren't liquid, there are options in the foreign markets. Given present volatility, a large speculator can purchase platinum and sell calls to establish a yield. The interest rate is negligible while leverage is effective. Thus, a substantial "return" can be synthesized using platinum. The result would be a speculative squeeze.
This would inevitably damage platinum because users would be forced to seek alternatives. If we have learned anything it is that innovation can find alternatives when faced with an economic impasse. Just as palladium was
embraced and then abandoned, so too can platinum be replaced by technological alternatives.
Obviously, Johnson Matthey is not interested in this development. Among the alternatives are water injected gasoline and diesel engines that boost power and efficiency by injecting water into the cylinder at the point of
combustion. The water turns to high-pressure steam by absorbing the heat of combustion. The expanded steam adds power to the cylinder while reducing emissions. Computerized ignition and fuel-to-air mixing further reduces pollution. The approach was considered by the European Union as an alternative to catalysts, but was too costly back in the 1980's. Since computer technology has come down in price while power has gone up, "lean burn" engines make more sense. Of course, implementation would take time.
Keep in mind that desperate times call for desperate measures. Having been held "hostage" by platinum and palladium, auto and truck makers may have the required incentive to embrace non-catalytic pollution control. Thus, what goes up will eventually come down.
Platinum's future remains bright because the most efficient fuel cells still rely upon platinum. Here again, high prices can be a strong incentive to research alternatives like nickel. While not an efficient substitute, nickel is being developed for catalytic and fuel cell applications. As with most technologies, time has a way of solving problems. In addition, not all fuel cells use platinum as the processor.
In the interim, traders have a wonderful opportunity to ride the wave if platinum experiences a brief return to glory. According to the JM forecast, opportunity exists in owning platinum below $800 and in the platinum/palladium spread that has already widened, but has the potential to go further.
Unlike platinum, palladium suffers under a surplus that is partly the result of the automakers flight from the Russian squeeze. Other fundamentals include a reduction in loading called "thrifting" and the proportionately smaller commitments to palladium autocatalysts moving forward.
I agree with the JM interim perspective, however, I believe palladium demand is waiting in the wings. First, auto manufacturers have had dismal records in hedging platinum group metals. This was exemplified when Ford wrote off $1 billion in palladium losses from a failed accumulation program. The market has reacted faster than auto and truck manufacturers. The only company that publicly announced reconfiguring platinum/palladium loadings in North America was General Motors.
With platinum heading towards $800, the platinum/palladium spread is simply too wide. Given the JM forecast, this spread is not likely to narrow within the next six months. If the retail holiday season goes well, I
believe auto sales will accelerated more than anticipated into the second quarter. This will generate more forward accumulation and perk up palladium interest.
More long-term developments hold promise for narrowing any surplus supply over demand as prototype hydrogen conversion units and fuel conformers begin commercialization. Palladium has unique hydrogen extraction applications and is also effective in removing impurities from liquid fuels intended for use in platinum fuel cells.
Overall, there is no escaping the vitality of the platinum group metals. Unfortunately, there is no rhodium contract. With less than a million ounces of new production per year, a rhodium contract could be squeezed beyond reality! Unfortunately, it will take an evaporation in the oil sector to bring the New York Mercantile Exchange into a more supportive role for their platinum and palladium contracts.
November 24, 2003
Philip Gotthelf
Commodity Futures Forecast
P.O. Box 566, Closter, New Jersey
201-784-1235
www.commodex.com
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