February 20, 2004
Gold Retest #2

Dollar Logs Biggest Weekly Gain versus the Yen in 5-years

Two Japanese officials -- vice minister for international affairs Zembei Mizoguchi and Finance Minister Sadakazu Tanigaki -- tried jawboning the Yen lower today. Mr. Mizoguchi and Mr. Tanigaki might have had some success at striking fear into the hearts of Yen longs on their own. However, what really clobbered the Yen today was Japan raising its terror alert to its highest level for the first time since March 2003.

As repulsive as it is to make light of ‘terror alerts’, the conspiratorial mind cannot help but wonder whether or not Japan has finally found a way to stop the Yen from appreciating.  To be sure, today’s alert out of Japan did more damage to the Yen than the $7 Trillion the government sold in Yen in January, and the $20 Trillion the government sold in Yen in 2003.

Currency Moves Hammer Gold

NYMEX increased margin requirements on silver (and copper) today. Before asking whether or not the first margin hike on silver since 1999 is a conspiracy or coincidence, it should be noted that commercial positioning before today’s margin hike - at least those positions reported in the COT – did not suggest that the commercials knew about the hike beforehand. Typically gold and silver sell off immediately following hikes in margin requirements, and, often times, commercials are positioned to profit from the sell off while speculators are not.  Silver dropped today.

By mid-day gold was hamstrung by the much anticipated short covering rally in the dollar, and in the early afternoon gold aggressively sold off below $400 an ounce.  Most of the COT statistics – namely commercial short interest which has actually declined in recent weeks - did not suggest that today’s dump was due. However, one statistic did.
 
As per the above chart, open interest in gold peaked as the price of gold peaked in early 2004.  However, open interest has since been in decline even as gold rallied back above $410 an ounce (today’s COT report showed less than 5,000 increase in open interest). The basic observation here is that, from a trader’s perspective, declining open interest means that gold is a less attractive  ‘play’.  This observation gains credibility when considering that the currency mayhem unleashed since G7 didn’t attract barely any new players to the gold party.

Granted, hindsight is 20-20, and analyzing open interest/COT trends is hardly an exact science.  Nevertheless, leading up to gold’s first retest of $400 an ounce ahead of G7 – a retest that some predicted beforehand (Jan 22, 04) - speculators were increasing their long positions with abandonment. In short, the jump in speculative long interest preceded the first retest of $400 an ounce, and the continued softness in open interest preceded today’s (or the second) retest of $400 an ounce.  


Gold Needs New Driver

The rebound in the US dollar could prove temporary, and gold could soon be busting above its former highs!

Before buying into this speculation it is worth noting that the greater likelihood is that the price of gold will languish until something unexpected happens. With this in mind, it is worth noting that unless a dollar sell off becomes chaotic or forces US interest rates higher, a declining US dollar is no longer an unexpected event. Quite frankly, that gold was unable to battle back to 15-year highs as the US dollar weakened to record lows versus the Euro earlier this week suggests that traders are reluctant to keep up the norm (the norm being, until this week, short the dollar and/or go long gold).  

What the next ‘unexpected’ development might be is difficult to pin down.  Rather, on a daily basis some central bankers are talking about potential gold sales while other central bankers are talking about currency interventions.  None of this conversation is likely to help build renewed interest in gold unless central bank gold sale restrictions are renewed and/or certain central bank intervention efforts fail.

In sum, the logic touted by many bugs was that since G7 yielded no new dollar doctrine that gold was off to the races again.  One dollar bounce has abruptly ended this race.

Remember that “a retest of the psychologically important $400 an ounce level could also bring with it a great deal of investor angst”….Speculative long interest is still at historically high levels. Are more weak hands about to be shaken? 

The gold accumulator should be prepared for the buying opportunity any further sell off might bring.


Gold COT: Excel


BWillett@fallstreet.com