COMMODITY FUTURES FORECAST
What's In It For Silver And Gold?
Philip GotthelfAlthough not as impressive, silver and gold have reflected the same bullish sentiment. These metals are more monetary in nature and are more correlated to changes in currency parity. However, their moves are also disproportionately high in comparison with the dollar's decline.
Gold tends to reflect currency changes more directly while silver moves in tandem. Thus, copper can continue trekking higher when silver and gold become stalled by monetary intervention or simply a trend change.
As I have frequently pointed out in previous reports, base metals are a significant source of precious metals. In particular, the majority of new silver is a byproduct of base metal mining with copper and nickel in the lead. The surge in copper becomes an incentive for increasing production. In turn, silver, gold, platinum, and palladium precipitate out to impact other supply/demand equations. This raises the question, "Will high copper prices bring down precious metals?"
This is not an immediate concern, but it does have implications for those who are inclined to accumulate physical inventories. Sales of silver coins have blossomed along with golden counterparts. If the intent is to protect against an outright meltdown of our paper system, hold on to the actual metal. If the purpose is speculative, stick with paper representations like futures and options!
Silver just displayed the first signs of profit taking with a bust below this week's consolidation above 76000. A close below 76000 implies a test of 73000 support. While this may appear inconsequential on the chart, 30¢ represents $1,500 per contract and is normally considered a very good move in the white metal.
The real technical minefield for bulls comes into play from 72000 down to 68000 where we see the progressively low 20, 30, and 40-day moving averages. Any decline into this area sets up a test of 67000 support. Is it the end of a marvelous bullish romp, or just a retracement in anticipation of $9!
The consensus among bulls is that any test below $7 will be temporary. They call attention to silver's extraordinary latency and the generalized rule that a breakout from such a base should achieve new highs! I cannot be as optimistic because a new high would imply a move above $40! However, I'm not laughing because the momentum in the Commodity Research Bureau Index (CRB) represents a significant precursor of inflation during a period when the Fed is reluctant to raise interest rates.
Washington emphatically insists inflation is under control. Absent food and energy, the decline in dollar purchasing power looks manageable. But, perhaps it isn't. If housing is only creeping up at 3%, it still is a compounding crawl that is draining pockets. Deception is apparent when examining the raw figures without considering exceptionally low mortgage rates. What happens when rates move higher? What proportion of loans are fixed versus variable?
The point is that we are all destined to wake up to the reality of higher prices. This is not to say that there are no arguments favoring deflation. For example, Robert Prechter of Elliot Wave notoriety has maintained that we are actually in a deflationary spiral. He has been predicting a price index implosion with dire consequences for stocks and the economy.
For traders, the more immediate influences are paramount. While highly risky, I am inclined to scale back on my bullishness in silver and gold in anticipation of continuing strength in the dollar.
Copper Touches Multi-Decade Highs
If you're not up on your historical price perspectives, copper zoomed through highs previously set when Sumitomo's metals division attempted to manipulate this important industrial metal. In fact, some predict copper will challenge $1.54/lb. set back in January, 1989.
Like 1989, the move toward the top has been exceptionally steep. Notice how the price has moved in nearly straight bars to indicate unexhausted momentum.
Unlike 1989, we do not face labor unrest in Peru. This was considered to be a catalyst in the 1989 price rise that, in reality, exceeded all rational expectations. Peru's production was reduced from 392,000 metric tons in 1988 to 300,000 that following year. An unusual set of demand circumstances combined with slight supply disruptions to produce a buying frenzy.
In the end, the huge price explosion created more longer-term problems than short-term good for producers. The 1980's represented a transitional time for copper production with the widespread introduction of highly efficient and cost-effective solvent extraction. The move from former smelting placed new mines on a fast-track to high output. Notably, Chile was developing ambitious copper facilities that were slated to be fully operational by 1991.
Electro-whining effectively plunged average costs from over 70¢ to under 60¢ per pound. Interestingly, even with twenty years of inflation, copper production costs have remained steady with averages just over 50¢. This means that investors should be buying the heck out of copper producer stocks! Profit margins are absolutely incredible for those who have remained reasonably unhedged. Further, financing cost are at 45-year lows. It is a potent combination of favorable circumstances.
Copper's unusually high price is not related to supply disruption. Rather, we are seeing unprecedented accumulations. In particular, China has blind-sided consumers with a highly organized buying blitz that was just recognized by today's Wall Street Journal in an article about scrap metal. Indeed, Chinese buyers have soaked up huge quantities of copper scrap along with steel and other base metals.
Thus, we see a contrast between the 1989 boom and today. 1989 was unsustainable. Today's demand-led price may carry further and longer. However, we must keep in mind that copper producers are more flexible and nimble. Most assuredly, Chile and Peru will rapidly expand output to take advantage of rising prices. True to Adam Smith, when you leave markets alone, they will adjust to equilibrium.
A 100% increase in copper since the beginning of 2003 is obviously more than an adjustment for declining U.S. Dollar parity. Even as the dollar moved higher, copper remained unaffected. The 40% parity differential expressed between the Euro and greenback is a far distance from the doubling we see in spot copper.
Europe Braces For Terror
In their infinite wisdom, the French decided to ban head scarves worn by Muslim women attending school. Timing could be or should I say, timing is everything. The Islamic response has been to warn France of the same treatment recently experienced by Spain...a primary nation involved in the Inquisitional crusade against Western European Muslims.
What Europe is discovering is that the scope of the "new war" extends well beyond the United States, Israel, and the United Kingdom. This is a true jihad against the Western civilization. Thus, Europe's economies are threatened by the same perils as the U.S. during a time of economic uncertainty. Since each European Community member is responsible for its own security, the coordinated effort is less efficient than our own Homeland Security approach. This is one of many reasons why currency traders are shifting from pro Euro to pro Dollar.
After making a double top, the June Eurocurrency settled into a consolidation triangle that was violated at 12250. This established a test of 12100 support which has held for the moment. With prices below the 20 and 30-day averages, I took a chance (again) on selling the Euro and buying the dollar index. We hung in the Euro by a mere 7 ticks after I measured for a resistance level that represented danger if breached. I used the same measurement for the dollar index and unfortunately (for now) was too close by about 8 ticks! Thus, subjective technical analysis...even when quantified by a formula...lacks precise accuracy.
But the key point I fundamentally missed when calculating the dollar index protection was the inclusion of the Japanese Yen.
After a powerful "V" bottom, the yen continued soaring with a minor consolidation below the current 9480 resistance. If the dollar gathers more momentum in general, the yen could have difficulty overcoming 9480. Regardless of this contest, the yen played a role in fooling us out of the long dollar index position.
I am inclined to try again with a wider stop. If the Euro cannot regain strength, there is a chance the yen will stall while the pound shares troubles with the rest of Europe. This means that the dollar index will present an agglomeration of the major currencies that share a downside bias.
What About Agriculture?
Now, I must admit that I am particularly miffed that I missed the all-time record in pork bellies. However, I have a legitimate excuse because I pointed out on our last unsuccessful belly trade that the volume and open interest has been steadily drying up.
This made me suspicious of become a target for manipulation as my subscribers entered the market in mass and generally used the same stops. How's that for conceit and paranoia! Still, I had the intestinal fortitude to buy into lean hogs and live cattle. The results have been offsetting for some of my losses experienced in other markets!
I may repeat my opening line If you're not up on your historical price perspectives, pork bellies have blasted off to all-time highs. If you're looking forward to those popular BLT sandwiches over the summer, you may see a price hike as the "B" portion is currently above $1. In every instance, a move above $1 was a warning of a dramatic reversal. The question is where and when.
I usually favor the hog/belly spread when it widens to such enticing levels. While we are not at the extreme, August bellies are more than 33¢ above August lean hogs. That's a big spread. Sure, it can go wider, but I believe it's worth a 3¢ exposure to capture a move that could narrow by 20¢ in short order. Moreover, I feel the spread is safer than an outright belly short since the stop is not as visible in the pit.
Agriculture has exceeded most analysts' wildest expectations. With U.S. farm production at the top of our export list, this sector holds the potential to alleviate some of our damaging trade deficit. This is another reason why the dollar could enjoy a recovery.
March 25, 2004
Commodity Futures Forecast
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