Breakout in Precious Metals

By Scott Silva

Editor,  The Gold Speculator

8-22-11

Silver is breaking out for another run to new highs. The metal is moving higher along with gold in the safe-haven trade. The precious metals are likely to get another push up from US economic policy-makers.

Gold and silver are benefitting from the flight to safety trade driven in part by the continuing European debt crisis and high volatility in the equity markets. Higher inflation, the US credit downgrade and slowing economic growth are also impacting equities; money is flowing out of equities and into hard assets.

We can see this dynamic playing out in the price of gold, which is testing new highs at the $1900/oz level. Gold’s rise this month has accelerated on a parabolic trajectory, while the S&P 500 has sold-off steeply.

Money is also moving from stocks into US Treasurys, despite the US credit downgrade. Yields on the 10-year Treasury are at historic lows, dipping below 2% for the first time since the 2008

financial meltdown. But real rates for Treasurys have been negative at the published inflation rate. And the tax man takes his pound of flesh not matter what. So many investors choose gold and silver.

While gold has been move steadily compared to stocks this year, silver has been more volatile than gold. Silver declined a bit more than gold back in May, and has been trading in a range since. That is until it broke to the upside in the last two trading days. We cans see price action for COMEX silver has produced a bullish ascending triangle pattern over the last several weeks. Ascending triangle patterns are reliable bullish indicators. We saw an ascending triangle pattern in silver back in September 2010 when we called a buy at $20.78/oz and a target of $60/oz. 

We can see that the pattern formed on declining volume, and that volume ticked up on the Friday’s breakout. This volume behavior confirms the chart pattern. The point count for the ascending triangle pattern above creates a near-term price objective of 47 for COMEX silver. We would consider the breakout indicator to have failed if silver closes below 42 on any near-term pullback.

The longer term outlook for gold and silver is bullish as well. For gold, we can see rising money stocks as the major catalyst for further price gains. Another bullish factor is extended economic turmoil in the Eurozone. The gold/silver ratio dynamic will help pull silver up along with gold. Any move by the Fed to implement additional quantitative easing will accelerate the rise of gold and silver prices from here.

The quantity of money in the economy is increasing. As we know from Milton Freidman and Henry Hazlitt, “Inflation is always and everywhere a monetary phenomenon in the sense that it is and can be produced only by a more rapid increase in the quantity of money than in output.” Fearing deflation would set in as a result of the financial meltdown in 2008, the Fed and central bankers around the world have flooded the place with liquidity. But, the Fed was wrong in 2008. Deflation was not the problem. The housing bubble burst, but prices in general were not falling into the abyss. The credit freeze was not a general phenomenon. Only a few Wall Street investment banks were locked out of the repo market on no confidence votes from counterparties. The Fed action to add $1.6 Trillion to the money supply was a gross over reaction to the tempest in the Wall Street teapot. The Fed’s additional $600 Billion QE2 stimulus measure also contributed to growing inflation for all.

And on the inflation front, it will get darker before the dawn. The reason is “excess reserves.” That is, Fed member banks have been sitting on $1.6 Trillion in cash and have been reluctant to lend. But some of those reserves are now leaking out to the general economy. We can see that from M2, the Fed statistic that measures money in circulation plus demand deposits, savings account balances and small time deposits, has increased by $500 billion in the last two months. So there is more cash available to chase the goods and services, the surefire path to higher prices.

Excess liquidity is causing inflation, which is showing up in producer and consumer prices. The US Producer Price Index has jumped to 7% year-over-year, which is squeezing corporate margins and flowing into higher consumer prices. The US is also importing inflation from China. Inflation in China ticked up despite several efforts by its central bank to raise reserve requirements and tighten rates. 

Gold is the premiere hedge against inflation, so we are seeing the price of gold move steadily higher. We can expect gold to reach $2000/oz and beyond in the next few months.  The gold/silver ratio is telling us that silver could outperform gold this year on a percentage basis.

The question for you is, “How can I protect myself and my assets from inflation and market volatility?”

Investors from around the world benefit from timely market analysis on gold and silver and portfolio recommendations contained in The Gold Speculator investment newsletter, which is based on the principles of free markets, private property, sound money and Austrian School economics.

The question for you to consider is how are you going to protect yourself from the vagaries of the fiat money and economic uncertainty?  We publish The Gold Speculator to help people make better decisions about their money. Our Model Conservative Portfolio gained 66.7% in 2010, and 55% for 1Q2011. Subscribe at our web site www.thegoldspeculatorllc.com  with credit card or PayPal ($300/yr) or by sending your check for $290 ($10 cash discount) The Gold Speculator, 614 Nashua St. #142 Milford, NH 03055

Steady as She Goes

By Scott Silva

Editor,  The Gold Speculator

8-15-11

High volatility in the markets seems to have become the norm lately. Equity markets around the world have whipsawed investors, as the indices swing wildly up and down in roller-coaster fashion. And the unruly changes from one day to the other are not small. When the Dow shed 520 points in a day last week, it represented a loss of $1.6 Trillion in capital for equity holders. Likewise, stock market rallies last week were sharp and short-lived, only to reverse in further massive selling. It’s no wonder that many investors have decided to head for safe haven assets.

There are many reasons for the recent high volatility in the markets. A major cause was the US debt ceiling deal. The markets sold off sharply when the deal was announced, which surprised some that thought that that raising the US debt ceiling would have a stabilizing effect and save the nation’s AAA credit rating. The markets reacted negatively on news of the deal, and by selling off on Thursday, August 4th, correctly anticipated Standard and Poor’s decision of Friday, August 5^th to downgrade, for the first time ever, the credit rating of US sovereign debt. In its press release, S&P said that “political brinkmanship” in the debate over the debt had made the U.S. government’s ability to manage its finances “less stable, less effective and less predictable.” It said the bipartisan agreement to find at least $2.1 trillion in budget savings “fell short” of what was necessary to control the debt over time and predicted that leaders would not likely achieve more savings in the future. The debt deal ducked the central issue, namely reducing runaway government spending.

Failure of the US government to solve its debt crisis was not the only factor that roiled the markets last week. A slew on new unfavorable economic data also pressured stocks. Consumer Sentiment, a key indicator of consumer demand, plunged in August to the lowest level since May 1980, adding to concern that weak employment gains and volatility in the stock market will cause households to retrench. The Thomson Reuters/University of Michigan preliminary index of consumer sentiment slumped to 54.9 from 63.7 the prior month. The measure was expected to decline to 62, according to the median forecast in a Bloomberg News survey. Unemployment remains high at 9.1% with no signs of improving. Food and energy costs continue to rise; buying power of the Dollar is shrinking, and wages are not keeping up with rising household costs. Housing values continue to fall, while rents are rising.

The Federal Reserve signaled its pessimism on the prospects of the US recovery by announcing it would maintain near-zero interest rates to 2013. The markets rallied briefly on the uncommon certainty of the Fed statement, only to sell-off again on the realization that the economy is grinding to a halt. US economic growth for the first quarter was revised down to 0.4%, down from 1.9%.  Most economists, including those at the World Bank, see US growth slowing, not accelerating over the next months and years. According to the World Bank, the US is leading the global economy into a “Danger Zone” of likely recession. The odds of a US double-dip recession are now 1in 3 according to economist survey data.

Fears of insolvency in Italy, Spain and maybe France and the uncertain response by the ECB also weighed on investors. European markets sold off, and the US markets followed with more selling. The question remains whether the EMU will survive chronic bailout measures, or the weaker members are allowed to fail and then cut away from the stronger Eurozone members.

One reliable measure of market volatility is the VIX Index. VIX is the ticker symbol for the Chicago Board Options Exchange Market Volatility Index; it measures the implied volatility of S&P 500 index options. We can see at once that the VIX reflects market sentiment. When the VIX is high, markets tend to swoon. When the VIX is down, the markets tend to gain. We see this dynamic in the chart below. Just before the market sell-off of 2008, the VIX reached 80. The VIX also climbed to 48 in May 2010 and reached 48 again last week, each time corresponding to big sell-offs in the S&P 500.

The Sturm und Drang that plays out in wild swings in the markets that ruin portfolio values and destroys wealth does not affect those that have prepared themselves against the onslaught. The key to the preservation of wealth is diversification. In today’s volatile economic environment, investors are finding once again, that owning gold provides stability as well as a store of value.

We can see how a portfolio that is diversified with gold performs well when the markets are volatile. Gold tends to be much less volatile than the general markets. Because gold has intrinsic value, gold is considered the premiere safe-haven asset. In uncertain economic times, investors cash out of stocks and low-yielding bonds and purchase gold. Significantly, today we are seeing the central banks are buying bullion. The World Gold Council's most recent figures show central banks are net buyers of bullion. In the first half of this year central banks net purchases totaled 208 tonnes of gold. In 1981, ten years after the end of Bretton Woods, the largest annual net gold purchase by central banks was 276 tonnes of gold bullion. Gold is proving once more it is the universal reserve currency. By the way, it was 40 years ago today that President Nixon took the US off the gold standard.

So how does gold hold up for the individual investor in volatile times? The answer is straightforward: Gold outperforms the markets in turbulent times. We can see the evidence in the chart below. It compares price action of the Dow vs spot gold over the last few months.

What is significant here is highlighted in the oval. It shows the 13% decline in the Dow in last week’s big sell-off, and gold climbing to over $1800/oz.  Investors that have owned gold in a diversified portfolio protected their wealth, while those that relied on stocks were savaged by the sell-off.  The DJIA has lost 1.18% year-to-date. The S&P 500 has lost 4.54% year-to-date. The Model Conservative Portfolio available to subscribers of The Gold Speculator has returned 43% year-to-date.  So for us, in these turbulent and volatile economic times, the order of the day is “Steady as She Goes.”

Investors from around the world benefit from timely market analysis on gold and silver and portfolio recommendations contained in The Gold Speculator investment newsletter, which is based on the principles of free markets, private property, sound money and Austrian School economics.

The question for you to consider is how are you going to protect yourself from the vagaries of the fiat money and economic uncertainty?  We publish The Gold Speculator to help people make better decisions about their money. Our Model Conservative Portfolio gained 66.7% in 2010, and 55% for 1Q2011. Subscribe at our web site www.thegoldspeculatorllc.com  with credit card or PayPal ($300/yr) or by sending your check for $290 ($10 cash discount) The Gold Speculator, 614 Nashua St. #142 Milford, NH 03055

Where the Smart Money Is

By Scott Silva

Editor,  The Gold Speculator

8-3-11

Many who hope to succeed in the markets seem to forget one of the primary laws of market speculation: Sutton’s Law. This axiom has proved correct time after time and is now used in several disciplines, ranging from law enforcement, physics, medicine, economics and market speculation. Sutton’s Law is described precisely by its namesake, William “Willie” Sutton, the prolific 1920’s bank robber who, when asked why he robbed banks answered, “That’s where the money is.” In the teaching of medicine, Sutton's law states that when diagnosing, one should first consider the obvious. Likewise, the FBI investigator puts a premium on physical evidence when building a case. Even the garage mechanic will check for fuel in the tank of the car that refuses to start before proceeding further. Sutton’s Law also applies to successful market speculation, where and important key is following the flow of smart money-- “where the smart money is”

So how can one determine where the smart money is going?  Well, one way is to follow the tape.

That is, the ticker will show price movement, up or down, for a given traded good. And the volume of trades pushing prices up (more buyers than sellers) or down (more sellers than buyers) is a primary indicator of market sentiment (bullish or bearish) and future market direction.  But, markets reverse, and there is the rub. Price action can reverse in minutes or over months.  So how can the speculator profit given the fickle nature of the markets?  One way that has proved itself over time is to apply Sutton’s Law: go to where the smart money is. In the commodities market, we can see where a big chunk of smart money is flowing by using indicators based on the CFTC Commitment of Traders (COT) data. So let’s examine the case for trading gold with the aid of COT data.

The Commodity Futures Trade Commission publishes trade data by the major players in the commodities market. These are 1) Large Speculators, professional fund managers and institutional traders, 2) Commercials, the industrial producers of the commodity, and 3) Small Speculators, private investors that speculate in commodities. Large Speculators tend to follow the market trends. Commercials tend to hedge, or bet against the trend in order to reduce price volatility risk. Small Speculators tend to follow trends as well. The Commitment of Traders data is collected weekly after the close on Tuesday and the Commitment of Traders Report is published after the close on Friday. COT data consists of the number of long and short contact positions placed by each of the player segments. Outstanding contract positions display current market sentiment of the holder. For example, if more Large Speculators hold long contracts than those with short contracts, then Large Speculator sentiment is bullish. Commercials are typically on the other side of Large Speculator trades, so Commercials tend to be short when Large Speculators are long. 

We can see the disposition of each player in the gold market as of last Tuesday in the chart below. The bars above the zero line represent net long positions; bars below the line are net short positions. We can see that Large Speculators have been increasing long positions in gold over the last month. At the same time, Commercials have purchased more short contracts. We can also see that Large Speculator bullish sentiment has moved up 4 points from last week to 87%.

This is useful information to keep in mind, but as my friend Jim Cramer would say, “Fine, but can you trade with it?”

Well, it turns out that COT data can provide very good trading information. The predictive property comes from movements of the COT Index. The COT Index is the net position of each of the major players (Large Speculators, Commercials and Small Speculators) over a 26-week period. As such, it is similar to a moving average. Changes in the COT Index tend to predict future price action. This is because Large Speculators tend to be trend followers and good market timers, and Commercials tend to be good at hedging against future market movements. We can see this dynamic playing out in gold in the chart below, which shows movement in the COT Index at the bottom.

We can see the COT Index for the Large Speculators (called Large Traders here) by the green line, and Commercials, the blue line. The COT Index represents net position change, so its scale is 0 to 100 percent. As expected, the COT Index for each displays the inverse relationship to one another. What’s important is the when major changes take place. For example, back in February, the Large Traders began to go long. We can see the price gold climbed in February to March. The Commercials, anticipating higher gold prices, loaded up on short contracts over the same period. In April, Large Traders added new long contracts, while the Commercials shorted some more. Gold surged to over $1550/oz by May.  In late June, Large Traders dumped their long contracts, and Commercials went long. Gold dropped $50. In early July, the Large Traders went long in a big way; the Commercials shorted in turn. Since then gold has jumped to over $1660/oz.

We can see that Large Speculators have earned their right to be considered “smart money” when it comes to gold. And that’s part of the reason subscribers to The Gold Speculator benefit from going to where the smart money is.

Investors from around the world benefit from timely market analysis on gold and silver and portfolio recommendations contained in The Gold Speculator investment newsletter, which is based on the principles of free markets, private property, sound money and Austrian School economics.

The question for you to consider is how are you going to protect yourself from the vagaries of the fiat money and economic uncertainty?  We publish The Gold Speculator to help people make better decisions about their money. Our Model Conservative Portfolio gained 66.7% in 2010, and 55% for 1Q2011. Subscribe at our web site www.thegoldspeculatorllc.com  with credit card or PayPal ($300/yr) or by sending your check for $290 ($10 cash discount) The Gold Speculator, 614 Nashua St. #142 Milford, NH 03055