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The phrase ‘Price of Silver Could Double’ should serve the purpose of reminding investors that precious metal prices can increase – and indeed double - quite rapidly. Silver did exactly that in 1979, as did the price of gold.
I am not going to contend that today is like 1979. It isn’t. However, there are some points of interest that suggest the possibility of an historic squeeze in precious metals is brewing. Specifically, three occurrences suggest that COMEX is losing, and may have already lost, control of the gold market.
1) During a week long, $25+ an ounce rally (Nov 15-22), open interest in gold (futures and options) rose by only 6,310 contracts. Open interest almost always mirrors the price action in gold. The last time gold rallied by more than $20 an ounce open interest jumped by more than 75,000 contracts.
2) NYMEX raised margin requirements on gold and silver last week*, but prices didn’t get driven lower.
3) During gold’s latest $4.10 an ounce rally (Nov 22-29), net commercial short interest actually declined. Are the commercials running for cover?
I’ll be the first to admit that these occurrences alone may not be enough to keep the price of gold from crashing in the coming weeks. However, consider another point:
Precious metal prices are soaring while the US dollar holds its own, stocks rally, and inflation expectations are thought by most to be contained.
In other words, silver and gold are rising for nontraditional reasons and/or based upon investor expectations (i.e. the expectation that Asian central banks will soon start buying gold, the expectation that too much global liquidity will eventually hurt the US dollar, and the expectation that foreign demand for precious metals will continue unabated).
Why is it important to highlight the fact that the current gold rally is based primarily upon ‘expectations’? Because gold rallies that occur in reaction to other events (i.e. last years rally as the US dollar dropped) inevitably attract a herd of (small) speculators, and this herd has a tendency to run for cover when their original investment platform weakens. That precious metals are rallying on expectations and not in reaction to a major even suggests that the so called ‘smart money’ is positioning themselves in the market, possibly setting up a major squeeze before the herd enters and pushes prices that much higher.
Another Price Collapse Around The Corner?
The alternative to the squeeze theory is that hedge funds and speculators have pushed gold and silver higher only temporarily; that hoarding is not going to happen; that no major event is going to come to pass before today’s gold bulls get nervous and start dumping. Usually I would be an avid supporter or this theory. Not today.
The potential problem with the price collapse theory is that the anticipated correction at the psychologically important $500 an ounce level has already came and went. If the commercials had the power to pummel gold lower they would have done so last week, and if the new money driving gold higher was short minded they would have probably taken more profits last week. Instead, after touching $500 an ounce gold started to correct but then marched right back above $500 an ounce. Not even during the 1970s did the psychological $500 an ounce barrier pass wish such ease.
$500 Looked Easy This Go Round
Back when the price of gold was just about to make its maiden voyage above $500 an ounce it got pummeled by double digit losses in two consecutive sessions. That was back in December 1979, or when OPEC was meeting to decide how much to raise oil prices by, Iran was holding US hostages and saying they wanted to trade oil in currencies other than dollars, the US stock market was collapsing, and the US dollar was wildly trading lower. Flash forward to today: gold is rising, and….Well, that’s about it: stocks are doing fine, the US dollar is firm, OPEC’s most important member is in America’s pocket, the average investor is happily allowing their capital to be rotated in and out of paper assets without care, and gold is rising.
Isn’t it remarkable that gold can be gathering so much force when the financial world is at peace?
In short, save a pickup in investment commentaries on gold, there is little evidence to suggest that a crazed mob of investors are chasing gold higher in a desperate rush to make short term profits. Rather, the crazed mob is still predominately in paper. This suggests that $500 an ounce may be only the first of many barriers to fall.
The handiwork of hedge funds or central banks?
Given that hedge fund flows are usually the headliners of the ‘hot money’ crowd, this would appear to contradict the speculation that the ‘smart money’ is pushing up gold. However, what hedge funds are also known for is buying positions based solely on the expectations of squeezing other parties (i.e. copper was given a push higher after it was announced the Chinese trader, Liu Qibing, was about to default on a massive short position simply because the ‘hot money’ wanted to bring about a squeeze). Could it be the case that the hedge/smart money is trying to sting the always short commercials and unshackle the gold/silver markets?
As for the argument that Asian central banks are about to follow Russia, Argentina, and South Africa and add to their gold reserves – an idea given credence to by a hedge fund manager in a recent Reuters story – this speculation warrants a little, buy not much, attention. Beyond the positive trend of declining central bank gold sales it should be remembered that there are very few major central banking outfits in the world today whose short term interests would best be served by buying gold. Gold is the competition to central bank paper. End of story.
Conclusions
Rising gold is a symptom of excessive paper in the system, and excessive amounts of paper invariably lead to inflation, malinvtesments, and/or currency deprecation. Knowing this, what may be required to turn today’s solid advance in precious metals into full fledge short squeeze is bedlam in other financial markets (as the result of too much money). The smart money seems to be positioning themselves in the precious metals market on the prospect that bedlam looms; on the prospect that the herd will soon start to fear paper.
“Stocks Post Sharpest Drop of '79; Surge in Price Of Gold Cited” Sep 5, 1979. NYT.
As for the topic of silver doubling, the silver commercials have spent each of the last two weeks padding their net short position despite positive supply/demand fundamentals and the threat of a serious shortage should the new silver ETF make it to market. Thus, it remains clear that the only way to produce a ‘squeeze’ in silver is for the price of silver to continue to trade higher and/or wait for the metal to run out.
In short, it is unknown whether the hot/smart money pushing precious metals higher today will bring about a once in a life time squeeze. What is known is that gold has now made new highs in December for the fourth year in a row but that the clock may be ticking…in each of the last two years gold has suffered a serious correction to begin the year.
* It should be noted in the history books that the same week the price of gold rallied above $500 an ounce for the first time in 22-years in 2005 that NYMEX raised precious metals margin requirements. The act of raising margin requirements is supposedly undertaken because of an unbiased computer program. History buffs know better (See Conspiracy of Coincidence?) In other words, given the inconsequential small spec position, the only reason for NYMEX to raise margin requirements today seems to be to try and support a dangerous commercial short position by capping gold at $500 an ounce. For the moment, NYMEX has failed.
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