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Gold Market and Precious Metals Commentary

January 5, 1999

Technicals -

Veeerry interesting. Gold started out the new year just about the way it ended the last one by stumbling. Yet, while the price of gold has been heading south, it is going down with great reluctance. It does not plunge and follow through on the downside with any vigor. The bullish consensus is a low 28 and the Comex Commitment of Trader report released today was decidedly bullish. The large specs are only long 8,194 contracts and they are short 42,270 contracts while the commercials are long 106,847 contracts and short 69,641 contracts. Even though the specs have been piling in on the short side as we noted to you in past weeks, the total open interest is only around 163,000 contracts plus, so the percentage of spec shorts relative to the total open interest is a high one. This, in and of itself, will not turn the market positive. But, combined with everything else that is going on around gold, it certainly adds a bullish flavor to the technical set up.

Silver really took to the bomb shelter and arbsorbed an early 16 cent battering, but actually managed to come half way back. If the silver market was in a bearish technical condition, this would not have occurred today. The $4.86 to $4.88 area is one of strong support and it held like a rock. Resistance is anything above $5.00. That is when the "squad" comes out selling. They have done so three times over the past months.

Fundamentals -

What a day! The CRB Index was up a strong 2.62 and closed at 193.84. Bonds and the dollar were very weak all day. And the U.S. stock market roared early ( Dow up 160 ) and then made a U turn to the downside to close around unchanged. All are anecdotal longer term positives for the gold market which has not geared up after the holidays yet.

As noted, the dollar really took it on the chin today. The euro closed around 118 and the yen finished just above 112. The yen is going into high ground against the dollar. Gold demand skyrocketed in Japan the last time the yen was at these levels in October. We would expect gold demand to soar again now in that country as the Japanese stock market is a shaky alternative.

Japanese Prime Minister, Obuchi, will express Japan's intention to push internationalization of the yen and turn it into the key currency in Asia during a visit later this week to France, Germany and Italy. They have already taken steps in this direction by making Japan's short-term government securities market more attractive to foreign investors. Interest rates in Japan are on the rise. The 10 year Japanese government bond ended the year with a yield of 2.01 per cent up from a record low .695 per cent in October.

Our sources have told us that the Japanese are concerned about the euro and do not want the yen left in the dust. They fear the euro's introduction might cause a relative decline in the yen's status as a global currency. Thus, Obuchi will propose establishment of a system of three key currencies (yen, dollar and euro ). The idea involves controls that would adhere to the principle of floating rates but limit exchange fluctuations to a predetermined range.

We also know that the Asian bloc is planning some sort of financial entity that will have regional IMF type status. This financial entity will have a "significant gold backing". We know the Asian official sector was a big buyer the past 6 months accumulating gold for this purpose. They pulled their orders in mid December and the gold market sold off. We expect them to be back in a big way in the near future.

In the last Midas, we stated that we expected the dollar to be "stoned" this year. Today, may be the tip off of that. As gold is priced in dollars, world gold demand should be much stronger this year over last as a weaker dollar makes gold more affordable in local currencies. Leader of the pack should be India. Demand for gold in that country probably topped 900 tonnes in 1998 ( which represents a 20% or so increase over 1997 and absorbs over one third of the newly mined, yearly gold supply ). As we sail into 1999, India's gold inventories are reported to be low and the best season for gold and silver demand begins in mid-January with the start of the marriage season.

Potpourri and the Gold Shares -

The XAU refused to follow the precious metals to the downside today and closed at 65.52 up .55. Technically, the XAU has turned slightly bullish as it closed above 65 resistance. The real test though is 70. A close above 70 could very well be a bullish sign that the bullion is ready to finally rumble.

The price of gold ended up the year at almost exactly the same price as it closed out 1997. Silver was down a tad on the year, but only because it started to move up late last year as a result of the Warren Buffet accumulations. Yet, most commodity prices dropped 10 to 70% per cent for the year. This is a clear indication to us that 1997 was a massive base building one for both gold and silver.

Several weeks ago now we notified Le Metropole members a buying group led by Goldman Sachs purchased $100 million worth of silver. We believe that Secretary Rubin's old firm, Goldman Sachs, has been the ringleader of the "goon squad" assigned to keep the price of gold below $300. When we heard that Goldman Sachs was a big buyer of silver we wondered at the time if it might have something to do with hedging some of their gold exposure. Gold has since dropped $10 in price and the short term need for the hedge dissipated. Thus, Goldman bombed the silver market right out of the starting gate this morning and was the cause of the early 16 cent move down.

Speaking of silver, the Midas camp thinks the price of silver will double in 1999 and reach $9.78 by the end of the year. Our thinking:

To a great degree, silver is a psychology kind of market. Known official U. S. inventories ( Comex warehouse stocks ) have dwindled for years and now stand at a very low 76,596,00 million ounces. If one had been told years ago that the stock number would be this low, we all would have expected the price of silver to be substantially higher because of the tight supply.

The price has not responded to the upside however, as one would have expected due to future price expectations and inventory accumulation factors. With gold continually failing to stay afloat above the $300 level and commodity prices in general dropping sharply during 1998, producers and hedge funds have been encouraged to sell silver rallies- always expecting the spec rallies to fail. Purchasing managers have relied on " just in time inventory buying" for their silver purchases. With the dismal outlook for precious metals prices, there has been no reason to forward purchase in size and accumulate large silver inventories. Eventual supply has never been in doubt so far and purchasing managers have cut down their capital costs by reducing their silver on hand.

It is also a psychological market for speculative investors. Many remember what happened to the price of silver in the inflationary 70's when the price went to $50 per ounce. Nothing could be farther from the late 70's scenario than the late 90's one. Commodity prices have been trending down, not shooting up. We have seen dishoarding, not hoarding. This negative psychology has severely dampened speculative commodity fervor and hard asset investing.

As a result of this present day thinking, it is our opinion that silver inventories are critically low all over the world and that pent up speculative demand for silver could be unleashed at any time. It is not atypical to see Reuters news releases such as this morning's-" Indian silver firm on low supply". The Indian silver premiums have been strong for many months which also indicates that silver inventories are low. In a sense, silver is a "sold out" market in a big picture way and that is why the price has rebounded from sell offs. A "sold out" market is a recipe for a price explosion - "sold out" meaning those that want to be short, are so. Therefore, we have run out of forceful sellers.

This opinion, by the way, contradicts the Martin Armstrong camp ( Princeton guru group ) that thinks the price of silver is headed for $2.80. They say the silver inventories in the U.S. have been moved to London to hide them from regulatory authorities. Others say that the Arabs have huge silver inventories in London, accumulated from the oil hay days, and will dump them on the market. Well, Brent crude has been trading below $10. Why have they not dumped this mysterious silver? If there ever was a time for Arab silver dumping, it is now. They know that most commodity prices have swooned. Why hold on? Why not at least start shipping the silver to India. The silver premiums in that country have been running 10 to 12%.

The other tidbit of information that is out there that indicates that this market is "sold out" is the contango ( forward prices ) continues to trade at less than full carry ( the interest costs plus storage and insurance ). This unnatural, pricing condition of silver suggests that the silver market is actually very tight. The spot price of silver is almost the same as the March futures contract. A change in psychology could unleash a super bull market in a blink.

It is mind boggling to me that only $370,00,000 could wipe out the Comex silver stocks. Remember, Long Term Capital Management, one hedge fund, was probably short 300 tonnes of gold which amounted to $2.9 billion dollars worth of gold.

There are many fundamental forces at work that can fuel a mega bull market in silver or precipitate an assault on the remaining silver stocks. Fearing a deflationary meltdown, governments around the world are turning on the monetary spiggots through their central banks. Slowly, but surely, paper is losing relative ground to hard assets. Y2K demand for silver bags has begun ( the silver bag premiums are also very firm ) and Y2K fears are bound to grow. This is a certainty as no one knows how this potentially serious economic problem will be resolved. It will be at least a year before we will have any real idea of the Y2K impact. That is one year of fear building - rational, or not. And finally, the powers to be have no central bank silver to bomb the market. Yes, they can play games for a bit as they have done recently, but at some point they will be very short of ammo and there will be no further point in keeping the price of silver down. They will have other battles to fight. Besides, it is just as likely as not, that officialdom will want to see a commodity go up as evidence that we are not going into a deflationary depression.

The price of silver will not wait for a psychological change to move higher - that will only flame the silver bullish fire. You have heard us say in Midas commentary many times, that a real silver move will begin with no fanfare - not because of a weak dollar or a world crises, etc. The smart money will move in first. Warren Buffet bought quietly in the summer of 1997, the news leaked, and then the price ran up $2 upon that revelation 6 months later.

That move was not sustained and failed because silver scrap came out of the woodwork and because of the previously mentioned factors. 1998 was a very bearish one for the prices of commodities. However, like gold, silver has a natural supply- demand deficit and has had one for years. Since the bull market in silver has been delayed, supply is being rationed off too cheaply. That supply is being run down. Available scrap was supplied to the market on the run up to $7.80 last year, so much of that my be gone and will not be there on the next price run up. That is why we think the price of silver will run up to $9.78 on the bull move this year.

One other bullet point. The price of silver can run up as fast or faster than any other commodity. In 1987, I participated in a silver price move up of $3. It occurred in a week. It can happen that fast and does. If we are correct about the silver commercial inventories being depleted, it could happen again some time in 1999 and probably will.

Bill Murphy (Midas)

After graduating from Cornell University, Bill was a starting wide receiver with the Patriots of the old American Football League and has been around the financial and commodities markets ever since. He owned a futures firm in N. Y. that specialized in precious metals and was a contributor to Veneroso Associates, a global strategic investment firm and producer of the 1998 Gold Book Annual.


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