COMMODITY FUTURES FORECAST
WEEKLY REPORT
Now That Inflation Is Acknowledged
Philip Gotthelf
The favorite word of the new generation is, "duh!" As mentioned in previous special reports, inflation has come back with a moderate vengeance. Over the past several months, I have called attention to the irrefutable evidence that consumer prices were rising and, more importantly, would continue rising through the second quarter. Virtually every component of the Commodity Research Bureau Index (CRB) had jumped by double digits...some by triple digits. Regardless of the exclusion of food and energy, core inflation also pulls from base metals, lumber, fibers, and other raw materials.
It should be no surprise that major food processors like Renold's Nabisco, General Mills, and the like have announced reductions in margins due to increasing commodity prices. These costs will be passed to consumers through higher end product pricing that is already in supermarkets. Those engaged in spring fertilizing have been hit with sticker shock as the standard bag covering 15,000 square feet has popped by more than 40% in most areas.
As the CRB chart illustrates, this venerable index rose 24% from its base formed last April through July. When considering the composite components, this represents enormous price pressure and a precursor to a rising Consumer Price Index. However, the Federal Reserve was concerned that the recovery had not impacted labor until the spectacular 300,000 job increased announced earlier this month. With a healthier job market allegedly in place, the Fed feels more comfortable about suggesting higher short-term rates in the "not too distant future."
The immediate and sustained reaction has taken the CRB Index from its highs to below the long-term trendline. The mere suggestion that rates can move up has sent commodities tumbling... for the moment. With the exception of energy, the threat of a short-term hike has busted most of the commodity up trends. In fact, the force of the decline has been enormous as seen by the speed and distance of the correction.
Stopping The Silver Bullet
Silver is among the severely wounded casualties of the war on inflation. While we were able to catch the beginning of the plummet, I was a nickel too conservative with my stop on the way down and we were nudged out just before the 70¢ plunge. While I cannot complain about taking a profit, I can cry over spilled milk.
The speed of silver's decline is not simply due to prospective interest rate hikes. Recall my warning that silver was subject to a swap from long May into short July. This was the strategy employed by Warren Buffett the last time silver approached new highs. Based upon my observations of the accumulation patterns, I was feeling comfortable a bust below 79150 in the July contract would signal a powerful reversal. Hence, I implemented a rare, but effective reversal stop strategy.
Unquestionably, silver had potential to move higher on a breakout above 83000 as the chart illustrates.
We see the triangle formed as prices peaked. Notice how a nudge above 83000 looks on the chart. It would have proven a continuation with an upside objective at 88000...another 50¢ from the breakout.
However, a bust below 79150 proved the opposite...that the triangle consolidation was an exhaustion with an approximate 76000 downside objective. For amusement, notice that the price did make a brief stop just below 75000. While it's not my precise measurement, this volatility has a tendency to stretch things out a bit. Hence, I moved our stop to 72550 after achieving 70510. This area is marked by the elongated flat circle that highlights the prior March stall. There was nothing to indicate a bounce from this test, but we saw it! Not to boast, but they may have been gunning for the collective stops of my subscribers. Perhaps I should vary the stops among subscribers to create a range!
Many subscribers called to determine whether silver remains a "good short." Based upon the chart, we need a dip below 61000 in July to confirm silver has more downside potential. I am inclined to reinstate our position on a bust below this support, however, the stop will require considerable exposure that may not be suitable for all traders. We saw how ineffective 25¢ can be and 50¢ represents $2,500 per contract!
Fundamentally, silver producers were putting out hedges as silver crossed 62500 and they have been averaging against production every since. My sources suggest an average sales price of approximately 64000 because there have been only two months of production in the move from 68000 to the peak. Even if we stretch another two months to the end of June, the average hedge price remains below 70000.
This means producers who sold July silver above the current price are going to deliver. Any accumulated inventory that is favorably hedged relative to the futures spot price will not be covered. It will be delivered.
Even industry representatives admit that silver demand has been static because of digital imaging. There is a misconception that digital photography completely eliminates silver processing. This is not correct. Commercial prints for digital images still use a silver-based development process. However, new inks and papers are rapidly encroaching upon silver-based printing, too. The picture is not particularly bright...no pun intended.
A great deal has been written about new silver applications. In particular, silver purification processes for water along with silver suspensions represent an increasing demand for metal. There is no positive correlation for silver in the comparison of declines in photo usage relative to increasing purification applications. The equation still favors a declining secular price trend. Still, silver is used in many other expanding areas. Thus, my former outside prediction for a price below $2.00 might be extreme.
Platinum Offers Frustration
I was disappointed by last week's $900 loss in July platinum as we sold at 91400 with an $18 stop. Like silver, I was conservative. But, I had the intestinal fortitude to re-enter Friday morning at 91400 using a 93250 stop, thinking that was sufficiently distant to keep us in play. I am significantly displeased by the bust that produced an 83100 low today with no end in sight since thin conditions were able to rally prices to initiate another loss of $950!
I further regret that I lost my nerve in our long June palladium/short July platinum spread because the narrowing was a 2-to-1 contract ratio (2 platinum to 1 palladium) yielding $100 per $1.
Several months ago, I pointed out that the Johnson Matthey platinum outlook as published on November 18, 2003 was bullish up to approximately $820 over the prospective six months. Anything above $820 represented an overreaction. This was my cue for seeking a top. Regardless of the adjustment for dollar parity, platinum prices exceeded reasonable levels for major industrial users like auto manufacturers and oil refineries. The switch back to palladium was one alternative. Conservation was another. Recovery is accelerating, too.
As much as producers refuse to admit it, ultra-low emissions vehicles designed around hybrid and lean-burn technology will eventually reduce automotive consumption. Alas, platinum is the primary ingredient of the modern fuel cell that has been receiving more publicity. In fact, there were Internet rumors circulating that companies in advanced fuel cell testing stages were accumulating platinum before public awareness. Fuel cell companies fear a speculative frenzy when cells advance to the forefront.
So far, traders we shouldn't worry. The price retreat is indicative of a bursting bubble. I do not expect fuel cell technology to be a driving force until several years of commercialization.
Technically, platinum formed a continuation flag similar to silver's consolidation triangle. The question was whether April platinum would penetrate 91500. I focus upon April because July presents a more erratic pattern that is difficult to identify. As we see, the flag was violated and prices never looked back. April exhibits a smooth straight line to the current levels. July paints a far more confused picture with several liquidity voids that can be cause for concern. As experienced traders know, such voids represent prime opportunities for excessive intra-day reactions.
Quoting the Johnson Matthey report, prices should trade between $700 and $820. Prices remain $20 above their highest prediction and $120 above their low. Where will prices establish some consolidation? My best guess based upon the chart is somewhere around 81000. However, if the dollar surges, this level could be highly temporary.
The Dollar
The most obvious catalyst for declining U.S. commodity prices is the greenback. I have been anxiously awaiting the turn in the dollar index and have been fooled into several false starts. Fortunately, our damage control has been good. Now, we have managed to lock into two healthy short positions in the Euro and pound. I avoided the index because I was unsure of the Far East component reflected by the yen and the sister dollars in Australia and Canada.
The choices were appropriate because the dollar has just broken out above the extended March consolidation. When compared to the Euro and pound, we have better movement and liquidity in both.
While interest rates are the leading force in setting dollar parity, we should keep in mind that the U.S. media has emphasized and alleged conspiracy between Bush and the Saudis to lower oil prices just in time for election boasting. If true, someone seems to have forgotten to tell the Saudis...or, the timing is just too early!
A bust in oil that is independent of the dollar will take a heavier toll on the British Pound moving forward because they depend upon North Sea oil for a good chunk of foreign revenues. A drop in oil should put more than just parity pressure on the pound.
In fact, the resiliency of the pound relative to the Euro may be reflective of the oil link. For the moment, our plate may be full with the pound and Euro. I would like to test the water with the yen and even the Canadian. But, that could present too much exposure since all the futures I track are traded against the dollar. Perhaps it is time to examine the Euro/yen?
April 22, 2004
Philip Gotthelf
Commodity Futures Forecast
P.O. Box 566, Closter, New Jersey
201-784-1235
www.commodex.com
Presented by:
CONSENSUS, Inc.
P.O. Box 520526
Independence MO 64052-0526
816-373-3700
Fax: 816-373-3701
editor@consensus-inc.com
www.consensus-inc.com
Email this Article to a Friend 
Printer Friendly Version