Last week's report mentioned the potential key reversals in energy, the dollar, and precious metals. With oil plunging and short-term interest rates rising, it seemed a matter of time before major sectors came under substantial selling pressures. As is common during major tops, the reversals come fast and furious. This past week has been no exception.
Gold collapsed from $452 to test 43500 support which is listed on the chart as objective #1. From there, February gold can easily decline to take out 42000. However, look at the range prior to October 1, 2004. We see a modest secular rise contained below 42000. This suggests that gold's propensity is to reestablish a range after adjusting for declining parities in oil and the dollar.
Once again, I was lured into thinking the range would establish within the consolidation we saw last week. I had been waiting for the bust for too long and finally gave in. We sold the April gold 450 call and put while buying protective wings for a "condor." Having collected net $18, we are safe to 432. Meanwhile, April gold is already down to 437. Ouch!
With this type of volatility, we may have an opportunity to cover the 450 call and roll down. The 435 straddle was offering $30 as of 1:00pm today that would give a range from 465 down to 405. The question is whether current fundamentals provide enough of a basis for such a boom or bust. Consider that the contract high was 46050 on December 2.
Die-hard bulls claim that the "blow-off" represents a 50% retracement from the 46000 high... give or take $10. The problem with this logic is that it does not consider January crude oil's precipitous decline from more than $55 to almost $40. This 27% decline since October 27 is nothing short of huge. In comparison, gold's dip from 46000 to 43500 is only 5.4%. When considering that oil and gold are priced in dollars, there is nothing to support an argument for gold's near-term return to former lofty levels.
I was anxious to participate in the eventual bust in precious metals. Yet, my timing error in the Euro forced me to become cautious. Rather than selling silver outright, I opted to take advantage of upside enthusiasm by selling the $9 calls two weeks ago for 14¢ and selling the 925 last week for the same amount. I venture to say that if silver had rallied further, I would have tried to add a 950 for 14¢ or better.
With March silver breaking from $8.20 down to $6.60 in about a week, I think it is fair to say this market exhausted. We witnessed a bust below a symmetrical triangle consolidation. Of course, the plunge in related markets helped accelerate and accentuate silver's decline. Now, the question is whether silver will continue the plunge, or find some stability.
Technically, silver has entered the approximate midpoint of its former trading range from July through October. The chart shows a band from 61000 to 70000. This was where we were selling call/put strangles in the fall. It may sound bold, but I am inclined to sell the same strangles today, or even entertain the condor despite the seeming trouble we have with last week's gold position.
The $7 call is quoted at 33¢ while the $6 put is 12ó. Given the drop, it would appear there is more exposure on the put if the plunge continues, however, the $7 call is closer to the money. The gross premium is 45¢ giving us protection from 74500 down to 55500. Clearly, anything is possible, i.e. a move from the current 68500 price to 74500 (60ó) or a decline to 55500 ($1.30). We see that even with the more precarious downside, the distance is more than twice as much as the upside.
Why trade options when the outright futures look so spectacular. Admittedly, if we had caught these moves last week, I would be a hero. Having missed these massive adjustments, there is a substantial back-draft risk. A market that can plunge and soar.
We were holding the long December Eurocurrency 13200 call, short two 13250 calls that expired Friday with a $1,387.50 loss. Today's 13370 close would have been preferable. Nonetheless, we were still in the loss column. Even with the bust in gold, silver, and oil, the Euro has hung tough...for now.
The December Eurocurrency has two gaps that may represent exhaustion from 13191 and 13100. With the 20-day moving average at the first gap, a bust below 13150 represents a confirmation that the Euro is under selling pressure and we have a technical reversal.
If the Euro joins the reversal fray, we will have a pivotal market event. This occurs when all markets have been powerfully trending in one direction and suddenly reverse. The question on many minds is, "Why?" What has fundamentally changed so dramatically as to cause the simultaneous collapse in so many markets? More questionably, if the dollar has not appreciably strengthened, what is causing gold and oil to drop like a stone?
The answer may be "anticipation." However, such anticipation should have transferred to the dollar to some extent. We presume short-term interest rates will rise in accordance with Federal Reserve statements. We presume that the economy remains healthy regardless of the weaker employment numbers last Friday. Yet, there are no major fundamental changes in the current news.
As we approach year-end, there will be position adjustments moving forward. Viewing this holiday season, we know the low-end consumer has felt the pinch of higher energy costs. Weaker sales at Wal-Mart with booming sales at Federated tell us that the Democrats may have been right to a limited extent. There are two Americas...the buyers and the would-be buyers.
Even without a great Christmas, all indications are that the U.S. economy has some traction. There is momentum. Now, a rapid decline in energy prices can add that extra spark to ignite a second round of investment market recoveries.
If you're like me, you are probably amused each time the Department of Labor comes out with the inflation numbers. The first statistics we hear are adjusted for food and energy. Without food and energy, what's left? Sure there is housing. But really...everything from transportation to heating and cooling is locked to energy while everything we eat is linked to food. Duh!
It should not take a genius to figure out that next month's inflation figures are going to reflect a serious decline. Look at raw materials from oil to metals. We're talking 5% to 17% declines.
The decline in raw agriculture also translates into an inflation stall. The only thing that can boost prices might be labor. But, the labor market is not tight. After all, what was Candidate Kerry saying? We have lost more jobs under President Bush than any other president. If this is true, there should be plenty of room for economic expansion without hitting a labor bottleneck.
Anyone who can remember the fall of 1985 should recall oil prices were on their way to $40 per barrel. By all accounts, we were looking at an eventual $50 price. However, Saudi Arabia was irritated by the lack of respect received from fellow OPEC members. Cheating was running high and the grip on supplies was slipping. In an effort to prove who was boss, Saudi Arabia turned on the pumps. In a virtual pumping free-for-all, oil crashed below $10 by the spring of 1986.
Recall my previous coverage where I pointed out that Saudi Arabia announced an increase from 8 million barrels a day to 11. A few weeks ago, their oil minister stated that they were seeking 12.5 million barrels per day.
If you look at the increase from 8 to 12.5, you see more than a 50% capacity jump in one member alone! When the so-called "experts" go on Fox News, CNN, and broadcast networks with their nonsense that OPEC is out of capacity, look at the facts. There is plenty of capacity out there and more on the way.
Whether you agree with Michael Moore or not, one thing is true. It is all about oil to a significant extent. Oil drives every Middle East economy with the exceptions of Israel, Jordan, and Egypt. Oil is the nearly exclusive source of terrorist funding for Islamic fundamentalist groups. The U.S. presence or "occupation" of Iraq takes the #2 producer out of immediate OPEC control.
We are getting ready for a major global shift in the energy sector that may even represent structural change. CIS production is coming on stream. The stabilizing Afghani government is already forcefully moving forward to secure major revenue resources. As the gateway between huge energy resources and transportation routes, a new pipeline will transfer everything from gas to oil between producers, refiners, and users.
Pushing oil to $50 was a good thing for producers in the short run. But the incentive to overproduce has been placed into the equation and a glut is a very real possibility.
December 14, 2004
Philip Gotthelf
Commodity Futures Forecast
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