HOUSTON (ResourceInvestor.com) -- Sizzling gold continued its relentless assault on gold bears and continued redefining upper resistance on the back of the buck. However, the rally is long in the tooth, mining shares are not answering the metal's move higher and the largest one-week reduction in ETF gold holdings since December 2004 suggests that the metal is outrunning its supply lines. Based largely on underlying indicators we track, the short-term, repeat short-term, outlook for this report turns cautiously bearish for the first time since a one-week stint in September of 2005.
This Week's Observations
Gold has been red hot. As of Friday, by this report's reckoning, this particular thrust of the Great Gold Bull is by far the highest and longest lasting upward surge any way one wants to measure it. Including in dollar terms, in percentage terms and in duration.
In percentage terms gold has more than doubled the July 2003 to January 2004 leg up of 30.5%. In dollar terms this leg up has nearly tripled the $91 advance from July to December of 2004. In duration this 48-week unbroken advance has lasted 19 weeks or over four months longer than the previous longest rally.
This week's continuation of the bull rally was largely fueled by a combination of extraordinarily strong momentum, continued dollar weakness (discussed below) and continued global political lunacy. (And the full moon isn't until the 13th this month!)
From Bolivia to Baghdad there were lots of gold-supportive actions underway in the world this week. There usually are, but when gold is in a bull phase anything causing uncertainty or that sounds threatening gives gold bulls another exaggerated justification for their convictions. When gold is in a pullback phase the reaction is much more muted.
Volume for mining shares has been quite high for an extended period. Investors chasing performance have continued to euphorically pump liquidity into the sector proving the long-held theory that increasing prices stimulate increased demand - up to a point. That point, of course, is where the amount of liquidity flowing in can no longer overcome the amount of profit taking and sector tightening imposed by the so-called "gatekeepers" of the market. More about that in a future report.
Nevertheless, a number of the industry barometer stocks are either in consolidations or have been trending slightly lower since February/March, a telltale sign that the metal is more or less on its own of late. More about that below.
Taking advantage of the rise in popularity of the mining sector, according to a Saturday Mineweb piece, Van Eck Associates filed a registration statement with the SEC for approval of a much needed U.S. ETF that would track a basket of forty-something gold and silver mining company stocks. Talk about a potential liquidity generator! Large investors, institutions and portfolio managers have the time and trading resources to build and maintain their own synthetic index funds. Numerous mutual funds also perform the same function, but an ETF that tracks a widely diverse pool of miners would probably have instant appeal to average investors and institutional investors alike.
Speaking of gatekeepers, despite a plethora of strongly bullish calls by a bevy of gold market watchers, such as in this roundup by Myra P. Saefong of DJ's MarketWatch, there has also been a growing queasiness among contrarians. That includes quite a bit of buzz in the broker/trader community regarding a series of margin rate hikes on the COMEX for both silver and gold. Silver in particular, which has seen margin rates more than doubled in two months. See this May 3 2006 notice from the COMEX. Compare to the March 7 2006 notice. Member and non-member margin rates were increased by 140% in about two months! Each time margin rates are raised it takes more liquidity to maintain the same level.
Hitting the Brakes
Did someone mention "sector tightening?" The runaway trains of momentum for gold and silver have been nothing short of awesome. You know, it takes a while to stop a fast moving train once the brakes are first applied.
The brakes are being applied from multiple directions it seems, including both public and private from major brokerages such as, among others, gatekeepers J P Morgan and UBS ... again. As we have witnessed in the past when major brokerages start throwing their collective influence in one direction it can have an almost immediate effect. Even if that effect is sometimes short lived or does not materialize, it is not something to be ignored. Almost certainly following those take profit calls, in a matter of a week or so, will come a rash of multiple valuation downgrades for individual high-flying mining companies. We can pretty much count on it.
Meanwhile, since Barclays Global Investors' iShares Silver Trust [AMEX:SLV] began trading last Friday, the trust has reported acquiring 1,368.5 tonnes of silver, valued as of 5/5 at $619 million. That's just one full week of trading, but intuitively this report expects that unless there is quite a jump in metal purchases by SLV in the coming week, just over half a billion dollars of silver off-take is not nearly enough to support the anticipatory run-up of silver prior to the SLV launch.
Anecdotally, regional bullion dealers report they are "swimming in silver" of all kinds except COMEX-approved 1,000 ounce good delivery bars (GDBs). 100-ounce bars, 10-ounce bars, generic silver rounds, silver eagles, 40% silver U.S. half dollars and 90% silver pre-1965 U.S. coins have been flooding from the public into local, and therefore regional, bullion dealers. Recent purchases by many of those dealers are immediately laid off to and shipped to the regionals and instead of premiums to the spot price they are trading at various discounts depending on the product. The discounts, while still relatively small, act as a sort of mini-hedge against silver's high volatility and suggest an unspoken skepticism of those front line market participants in the current silver price.
SLV silver purchases for the Tuesday-Friday reporting periods were 342.1, 202.1, 108.9 and 62.2 tonnes respectively. Note the sharply falling trend in purchases. One thing that would change this short-term tarnished silver outlook would be if there was a pronounced escalation in silver buying by the ETF this coming week, but that is probably what it will take for silver to hold this price level short term. This report believes that the current price factored in a much larger immediate response to the ETF.
Long term, however, as more liquidity finds its way into the ETF, as more metal is removed from the silver market and the metal's popularity continues to grow, the silver price is probably sustainable at much higher levels.
Jumping to the indicators for this week, the signals are still somewhat mixed, but now favor the bearish case more than not.
Please see a related RI article by Jon Nones regarding recent word of the reported . The "Oracle of Omaha" is out of the silver business for now.
COT Changes. Tuesday 5/2 commitments of traders report (COT). Large Commercials (LCs) combined net short positions (LCNS) +4,865 to 171,720 contracts net short. Gold Tuesday to Tuesday +$37.73 to $668.80. One-week LCNS rate of change (ROC) +129 contracts per dollar advance in metal. Modest increase in LCNS despite largest Tuesday to Tuesday percentage advance in gold since January 2003. By itself this indicator is still bullish and by Friday gold had tacked on another $13.77 to $682.57.
Total COMEX gold open interest +5,431 lots to 359,539 open contracts. Long-term, February '07 and beyond COMEX forwards increased another 2,538 to 51,468 or a now significant 14.3% of open contracts. Suggests continued increase in long-term hedging.
To view the commitments of traders report graphically try this link. LCNS-Gold Graph as of Tuesday:
Gold ETF. Gold holdings for streetTRACKS Gold Shares, the largest gold exchange traded fund [NYSE:GLD], declined 4.74 tonnes to 353.80 tonnes into the strong gold rally. Although the reduction in gold holdings is fairly small by GLD standards, it is the largest one-week reduction in GLD gold holdings since December of 2004! Possibly this is answering private and public "take profit" calls by some major brokerages. A reduction in gold holdings and share redemptions into an advance for gold is worrisome for gold bulls. No significant changes to other WGC sponsored ETFs for the week. Financial data for GLD updated daily at streetTRACKS Gold Trust.
Gold Charts. Gold closed Friday at a whopping 33% above its 200-day moving average as seen in the daily chart. Gold continues the process of redefining short-term upper resistance.
U.S. Dollar. As expected, large commercials jump long in a big way adding 7,642 contracts to their net long position to 8,203 contracts net long as of Tuesday. Dollar index dives another 153 basis points to 85.81 Tuesday to Tuesday. Since Tuesday USD staggers another 64 ticks to close Friday at 85.17, below August 2005 turning low. Greenback now strongly oversold as shown in the 1-year daily USD chart. Strong increase in LC long positions suggest the LCs are betting against further dollar weakness short term and probably expect the buck to rally from the 85-86 region.
Gold Indexes. While gold powered higher largely on the falling dollar, mining shares way-under-performed the metal for the week. As shown on the 6-month daily HUI chart, while gold seemingly defied gravity the miners could not answer in kind, at least not yet.
HUI:Gold Ratio. As seen in the one-year daily HUI/Gold ratio chart, mining shares strongly under-performed red-hot gold metal for the week. While anything is possible when talking about the future, mining shares often give advance indications worth noting near short-term tops and bottoms. Mining shares signaling collective skepticism for further metal advances. For context, here is the 2-year, weekly HUI/Gold ratio version. This is this week's most bearish indicator.
Yikes! Spot gold minus the HUI index leaped up by over 27 points this week to a bull-to-date record 302.48. Something has to give. Readings this high sound a klaxon with flashing lights. Either the metal needs to pull back or the shares need to rally. Odds favor the former very short term. Given the enormous short positions still probably in place on many miners, the latter would send mining share bears out of the pits on gurneys.
Commentary and Short-Term Outlook: Cautiously bearish for both gold and mining shares. Mining share underperformance, ETF gold selling and LCs big jump in dollar index long positions suggest the gold metal rally is running on fumes.
On the bullish side of the gold market ledger, the seemingly unstoppable upward momentum for gold and the only modest increase of the large commercial net short positions on the COMEX into the largest bull-to-date Tuesday to Tuesday advance for the metal argue that further gains are certainly possible. Especially in light of the continuous caveat of troubling global political and religious tensions which could erupt at any time.
On the bearish side, as we head into a traditionally weaker part of the annual cycle, we have to note high volatility on relatively high volume for the miners and their underperformance relative to the metal. Consistent high volume that does not translate into meaningful advances is a sign of increased distribution. Aggressive insider selling and a virtual absence of insider buying suggest that the smartest money in the gold market game has been cashing in chips strongly since February.
Although just one weekly report, gold selling by the largest gold ETF suggests a shift in money flow from positive to negative. Traders ought to keep an eye on the GLD money flow going forward. The big increase of the large commercials to their U.S. dollar index net long positions suggests the largest traders now expect a dollar rally short term. Meanwhile, different branches of those very same large commercials are issuing take profit calls for the metals sector following harsh margin rate hikes on the COMEX.
Gold has reached an amazing 33% above its now rapidly rising 200-day moving average after a 48-week unbroken definition move up. It has just completed its eighth straight weekly advance and is strongly short-term overbought.
Although upward momentum has reached a rare level and the metal could continue its meteoric rise just on momentum alone and without the support of the mining shares, short-term indications suggest that a typically sharp bull market style pullback has now become more likely than not. In this report's opinion, the probability is that gold has now come within 3% of at least a short-term turning high, if that high was not already established intra-day on Friday at $684.91.
Consequently, subject to the caveat below, this report turns cautiously bearish for the first time since a one-week stint in September of 2005. For short-term traders and speculators cautiously bearish means that no new long positions should be established for the time being, limited calls can be sold and limited short positions and put options can be considered, especially into any further rallies, if any. However, given this bull market's past ability to slay gold and mining share bears, new short positions should only be attempted with the tightest of new trade trailing stops.
Also for short-term traders and speculators, stops on existing long trading positions should remain at the "at resistance" level.
Repeating a comment from last week: "By using tight trailing stops rather than just selling outright a trader can potentially participate in continued strong advances, if any, while protecting short-term trading ammunition and/or significant profits if the opposite occurs. While each speculator's personal situation is unique and each short-term trader should study the issues carefully and make their own trading decisions, this report believes an at-resistance (tight) trailing stop strategy continues to be warranted."
Caveat: Given the enormous underwater short positions already in place world wide on gold and on many gold miners, any exogenous political or natural disaster shock to the global political tinderbox could ignite yet another firestorm short-covering rally at any time. Stops should be placed accordingly.
High volatility and wide ranging days remain very possible short-term. Careful stop management is a must. Be careful out there.
Long-Term Outlook: No change. A secular bullish perfect storm trend for precious metals continues. Rapidly escalating global investor demand, easier participation by investors via ETFs, conversion of Middle East petroleum dollars to gold, rising new demand from Asia, possible central bank buying partially offsetting central bank selling, conversion from dollars to gold by large U.S. dollar denominated foreign exchange reserves, declining gold production, increased political and NGO interference to bring new sources on line, rapidly escalating costs to produce, delays and shortages of equipment and manpower, previous two-decade bear-market-induced shortage of intellectual capital for miners, safe-haven buying to hedge strong, reckless, competitive dilution of under-backed fiat paper currencies and continued troubling global political and religious tensions are just some of the factors contributing to the bullish winds now blowing. In real terms gold remains undervalued versus nearly all other commodities and strongly undervalued as measured by the world's fiat paper promises. ... The Great Gold Bull has a long way to go. It just won't go straight up.
With that said, as always, MIND YOUR STOPS.
The above contains opinion and commentary of the author. Each person should study the issues carefully and, as always, make their own informed decisions.