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Last week the commercials padded their net short gold position (futures & options) by 22,857 contracts. This was the largest weekly increase since September 20, 2005, and marks the third week in row the commercials have added to their short position. All toll, the three week increase in the commercial net short position is 43,868 contracts -- this during a period when gold has rallied by $40 an ounce!
Ordinarily, of when the COT ruled the gold market, this strong of an increase in the net commercial short position meant only one thing: that crashing gold was around the corner. Today, however, a strong increase in the commercial short position could mean that the fabled short covering rally that coincides with dealer defaults and financial chaos is threatening to emerge. If you map out at what price the commercials have added to their shorts (not an exact science mind you) the 4.3 million ounces that have been sold short since March 14, 2006 are currently carrying a loss of $87.7 million. Add to this the additional 134,311 contracts the commercials were already short before March 14, 2006 and you are now talking about a position that is essentially a $10.6 billion bet against gold. Obviously how this position gets unwound will play an important role in the near term direction of gold.
As for silver, after a failed attempt to hold gold’s brother below $10 an ounce the commercials have not aggressively tried to dump sell orders on the market, yet…
Gold COT ~ Silver COT
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Since 2000 a lot of discussion has focused on whether or not the Fed should target asset bubbles. Unfortunately, what this debate has not done is zero in on something the Fed always targeted before the 1990s: GOLD.
The price of gold surpassed $600 an ounce today for the first time since 1981. What is remarkable about the latest surge in gold is that it didn’t arrive on the heels of a major US Dollar scare, record oil, or heightened geopolitical uncertainties. Rather, gold’s latest rally has, at least according to a prescient call from Bloomberg to begin the week, been the result of funds and investors “buying bullion instead of U.S. bonds”. That further speculation arrived yesterday that China is looking for reserve alternatives obviously didn’t hurt the gold market either. For its part, silver reached a new 22-year high today as it continues to ride the momentum wave created by the approval of a silver ETF.
While it is certainly possible that gold could be slammed lower tomorrow or that central banks will recant and confess of a renewed love affair with the US dollar, the more likely scenario is that precious metals will remain underpinned by a positive set of fundamentals. These fundamentals include central bank diversification away from the dollar, little producer hedging, unsustainable US borrowing trends (current account deficit), and renewed global investment demand. This bullish backdrop for gold represents the biggest and least talked about threat to Bernanke.
What Can Bernanke Do?
To begin, it is in the Fed’s bests interest to keep the price of gold in check for two reasons:
1) Rising gold can mean that the threat of inflation is on the rise.
2) Gold can, and historically has, become the currency of choice for investors during times of crisis.
Keeping the price of gold in check requires fiscal discipline (it may also require a meeting of central bank minds to come up with a Bretton Woods III type agree, but such a meeting is unlikely to arrive until after a financial crisis arrives). Specifically, in order to restore sound money policies Bernanke has to prove that US dollar stability is more important than short term economic growth. Accomplishing this seemingly impossible feat would likely require more rate hikes than most think likely, controlling the money supply, and, possibility, manipulating long-term US interest rates higher (if Bernanke says that manipulating yields lower (2002) is an option why not push them higher?). Mr. Bernanke also needs to bring back a mantra that has not been repeated in many years: “a strong US dollar is in the best interests of America”. Although the fallout in the America economy could be great, if Mr. Bernanke does these things the price of gold will drop.
Bernanke Beware
The problem with trying to adopt a disciplined monetary stance is that US policies are currently being guided by the unstated goals of currency debasement and profligate spending. Moreover, in the myopic eyes of most policy makers, these reckless policies have worked fairly well in the face of seemingly insurmountable economic challenges. In other words, convincing people that believe ‘deficits don’t matter’ to do a complete 360 and enact Volckeresque ‘tough love’ actions is extremely difficult to do.
Regardless, if gold is one explosive surge higher from returning to the safe haven currency of the world then this means the US dollar is one step closer to irrelevance during times of crisis. Hot money moved into Japan during the 1990s and when it left (shortly after the Plaza accord) it destroyed the Japanese economy. Although on a smaller scale, the same hot/cold story has been repeated many times since the Japan experience, and it is at threat of being repeated again in many emerging markets today. Like it or not Mr. Bernanke, the slow drip of global savings being poured into the US economy by unprecedented amounts can quickly come to be regarded as ‘hot money’. All it takes is a viable alternative to US dollar hegemony for the threat of an exodus of investors out of America to become a reality. Gold is such an alternative Mr. Bernanke.
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