August 9, 2004
Beware of $400 an ounce
By Brady Willett

Following the weaker than expected payrolls report the dollar was pummeled and gold and silver rallied. Given that the Fed may not be able to raise interest rates as aggressive as previously thought, many foresee the weak dollar/strong gold trend continuing for some time.  No disagreement here. However, unless - or more precisely until - the dollar collapses $400 an ounce may prove to be a formidable hurdle for gold.  Why?  Because the commercials have been attacking this psychologically important mark with vigor and great success. 

To note: this is not to say that the commercials can somehow magically cure the pickle the Fed finds itself in. On the contrary, if Greenspan is unable to raise interest rates for fear of further economic retrenchment it is nearly universally held that the dollar will remain vulnerable.  The commercials can not do much to change these facts of life.

However, what the commercials can do, and have done, is bide their time when gold rallies, and then swamp the market with short sales at the opportune moment.  Case in point, when gold was nearing its January highs the commercials aggressively took their largest short position on record.  The timing of this attack was, quite frankly, perfect.


Needless to say, with only 134,000 short contracts on the books today (as of Aug 3) the commercials are fully capable of adding to their shorts at any moment. With this in mind, last weeks impressively rally – which was capped at the $400 an ounce mark – could be an ominous sign.*.  The last time the commercials attacked $400 an ounce in July it took less than two weeks – or a 41,355 jump in short contracts - to crush the weak hands (see “Mini Attack” below)..


 Will $400 an ounce be conquered more quickly than $300 an ounce?

On November 27, 1997 the price of gold fixed below $300 an ounce for the first time in more than a decade. Over the next 4+years gold would try to regain the $300 an ounce level no less than 15 different times. The last, and perhaps final time gold fixed below $300 an ounce was on March 27, 2002. 

On December 1, 2003 gold fixed above $400 an ounce for the first time since March 27, 1996.  Less than 1-year since gold first touched $400 an ounce and there have already been 9 unsuccessful attempts to sustain this level (an unsuccessful attempt being a close above $400 an ounce that is followed up by any close below $400 an ounce).  

Conclusions

In July the commercials showed the gold market who is boss [again].  To be sure, the commercials pushed gold below $400 an ounce, and the speculative longs have dumped with abandonment – the 22% decline in speculative long interest for the week ended Aug 3 marks the worst such weekly decline in more than a year.  

A washout of speculative capital and a more ‘bullish’ positioning of the commercials (lower short/long ratio) suggested that gold was primed for a rally last week.  However, the data, unless you were on the inside, was not released until after the week was already over.  As is always the case after a sharp move in gold, the data is now almost useless.

As for the term ‘bullish’, it is worth remembering that the commercials have not held a net long position since December 11, 2001.  * Although there remains the possibility that the commercials will go net long again one day, for now a positive outlook for gold is when the commercials are less bearish (i.e. last week’s 1.89 short/long ratio has been a bullish number since 2002). 

In short, for the newcomer in gold the old $300 an ounce methods of accumulation apply today using the $400 an ounce level. In other words, accumulate gold under $400 an ounce but do not buy gold much above $400 an ounce (or as the commercials start becoming too deep into the short game to do anything but sell more paper gold). As for selling your gold, this does not become an option unless - or more precisely until - the dollar collapses.


GOLD -- Open Interest (av. open interest by month)      

 

 

 

Year:

1998

1999

2000

2001

2002

2003

2004

Dec

151,707

156,175

113,367

111,205

190,682

277,229

?

Nov

164,217

185,850

134,035

113,601

165,827

276,180

?

Oct

186,745

218,246

132,278

126,114

163,531

254,120

?

Sept

185,545

208,450

132,366

122,777

165,477

282,228

?

Aug

190,042

192,828

125,789

117,408

146,358

220,484

217,814

July

168,388

208,746

138,596

113,084

165,770

198,488

240,818

June

171,466

207,382

142,465

116,695

174,717

199,758

224,863

May

158,563

194,307

162,716

118,938

191,022

191,362

251,979

Apr

182,848

198,398

154,639

121,390

160,707

175,932

278,246

Mar

179,896

180,160

159,503

126,741

143,405

189,180

257,948

Feb

171,198

184,812

156,029

142,841

144,755

214,145

239,372

Jan

181,130

177,772

151,032

132,295

124,441

219,522

284,411

Aug 2004 -- For 1 week only

 

 

 

 

 

Highest average monthly gold price (for year)