Today In Silver

I’d like to apologize again for my absence and lack of updates over the past two months but it is probably meaningless given how many times I’ve already apologized, so instead I will just try to get back into the swing of things going forward and hopefully I will be able to keep things up. We have been working on some Metal Augmentor updates as well so I hope to have some emails sent and content posted very shortly — I would like to note here that the one year of subscription access will not actually begin until we have an official launch of the site which still has not happened. I should also be receiving the recovered video files (they somehow became corrupted and I have not been able to convert them to compressed streaming format) from the last day of the GSUL Canberra conference by this weekend and I hope to post and send out these videos as soon as I have them. Last but not least on the administrative front, I’ve been able to clear up a lot of the spam comments that have infected the site in the past few weeks. Unfortunately, I may have inadvertantly deleted a few legitimate comments and I’ve also had to temporarily restrict posting to those who have registered and are logged in. Ideally, I will be able to remove this restriction later if the volume of spamming decreases. For now, if you are having difficulty posting comments, please email to let me know.

In terms of the gold and silver markets, the monetary metals made very impressive moves today that put a halt to a potentially troublesome decline that had as its downside target a capitulation bottom in gold that could have breached (and may still breach) the $680 or so low made in November. [There are signs that silver's own $8.50 low from the end of October would not be breached should gold swoon to new lows as I'll discuss further below.] Fortunately, today’s action substantially decreases the likelihood of a collapse in the gold price but until gold clears the $888 level on the basis of the cash price, there remains the risk of a substantial decline. This risk is primarily a technical risk due to the pattern of lower highs and lower lows that goes all the way back to March 17, 2008. This chart pattern has dominated the action in gold for almost a year with a number of distinctive and convincing data points as follows (prices are for cash gold):

High #1 on March 17, 2008: $1,032
Low #1 on May 2, 2008: $846
High #2 on July 15, 2008: $988
Low #2 on September 11, 2008: $737
High #3 on October 10, 2008: $932
Low #3 on October 24, 2008: $683
High #4 on January 2, 2008: $888
Low #4 on ???: Below $683 to continue pattern

Within this larger pattern is a smaller, recent, pattern of higher lows and higher highs as follows:

Low #1 on October 24, 2008: $683
High #1 on November 25, 2008: $831
Low #2 on December 5, 2008: $742
High #2 on January 2, 2008: $888
Low #3 on ???: Above $742 to continue pattern (so far so good)

Assuming it continues to be in play, the longer-term chart pattern (which is quite bearish) may have put in a high just two weeks ago at $888. If so, this level must be convincingly breached to mark a breakout from the downtrend. At the same time, the shorter bullish chart pattern will remain in play as long as its $742 low holds. In any case, until we get a breakout above $888 — ideally involving gold closing above that level for three consecutive trading sessions — we cannot be too confident that the final low was made at $683 in October 2008. This is a fairly important consideration especially for those holding trading positions because a break of the $683 level could very possibly result in a powerful washout or capitulation that sees gold close the session near or even above strong support at $650 but first getting taken down perhaps as low as $550 on an intraday basis. Needless to say, those not protected by substantial margin would be wiped out by such a move. In terms of time, I give such a scenario no more than 60 to 90 days to play out. Alternatively, if gold should not break out (up or down) but rather remain rangebound between $683 and $888 until late April, the odds of $683 being the final low and the high on January 2, 2008 being merely an intermediate high will increase substantially.

In terms of silver, we find a similar but less distinctive pattern of lower highs and lower lows in the longer term within which there is also a recent bullish pattern of higher lows and higher highs. The relevant prices for silver (again on the basis of the cash price) are the low of $8.45 made on October 28, 2008 and the high of $11.74 made on January 5, 2009. A good chance of confirming $8.45 as the final low will exist if silver can hold the $8.80 level until late April or if silver can break $11.74 and stay above it for three consecutive closes. Conversely, a drop below $8.80 will very likely result in an immediate test of the $8.45 level. Unlike gold, however, I do not expect a significant washout move in silver far below $8.45 should that level crack. Indeed, I predict the emergence of very strong physical and speculative demand between $8.80 and $8.45. Crude oil does represent a major wild card in this scenario because a further collapse in its price toward the $20 level could create significant pressure on silver. Of course, such a washout in crude oil (representing a 50% plus decline from the current level of the active futures contract) would put considerable pressure on all commodity prices.

Speaking of crude oil, its fundamental situation continues to deteriorate as each of the past three spot contracts have sunk into oblivion as they reached expiration. This has created contangos of several hundred percent on an annualized basis. Given that oil futures expired in tremendous backwardation several times in the past year, this is an incredible turn of events. Of particular interest is the longer term contango (the one I am tracking is the 6-9 month contango currently represented by the August and November 2009 contracts), which is now hovering around 20% annualized after approaching 35% last month. As you may recall, in the summer of 2001 right before crude exited its bear market the 6-9 month contango had reached 50% annualized.

What appears to be happening in the oil market right now is that a growing component of demand consists of a very short term deferral of spot supplies by arbitrage players who are leasing storage capacity and selling futures against these supplies. Yet in the face of this “offtake”, spot demand has remained so weak that none of the deferred supplies are being drawn down and instead they continue to be rolled over month after month. In addition, the deferrals appear to be growing according to the inventory data yet there is no corresponding effect so far on prices further out on the futures curve. For example, February 2010 crude is trading at almost $60, about $10 above its recent low, while cash crude is currently flirting with its December 2008 low in the mid-$30’s. Absent the contango moving further out on the futures curve as it did in mid-2001, there is a good chance that crude oil may not complete its bottom regardless of how low the price might go.

Getting back to silver, we’ve had some very strong additions to the ETF holdings recently with the Barclays iShares silver ETF (SLV) now holding almost 230 million ounces of silver, representing an increase of more than 10 million ounces since the beginning of the year and over 17 million ounces since mid-December. This is quite a development and the pace may even accelerate should the price of silver drop toward $10, which is one reason why I believe the October 2008 low of $8.45 will not be threatened too seriously even if gold (and perhaps even crude oil) make final capitulation lows in the next several months. Already silver is trading at a gold:silver price ratio around 75 after having traded as high as the 90 level during the past several months, and I expect the ratio to gradually improve in the favor of silver during the months ahead.

Moving on, let’s take a look at the COMEX warehouse action, where we find that all that talk about taking delivery of December COMEX gold (and to a lesser extent silver) to be followed by removal of the bullion from the warehouses has so far resulted in very minor changes in warehouse positions. But before we completely dismiss the possible effect on prices that the growing chorus of taking COMEX delivery could allegedly create, allow me to note that the off-month January 2009 contract in both gold and silver is seeing a moderate amount of delivery interest that, in the case of gold at least, is several multiples of the typical level for this contract. Silver, too, is running above historic levels but not by such an enviable margin as gold. Yet given recent history such as the strong delivery demand for COMEX silver in March 2004 and May 2006 as well as the possibility for these types of “grassroot” efforts to snowball, it is not inconceivable that we could now be seeing the tip of an iceberg in COMEX warehouse delivery demand that could manifest itself in full by the time the April to June contracts go into delivery. At a minimum, the trend of delivery notices and warehouse holdings bears very close watching during the next several months.

My ongoing examination of the gold and silver basis reveals a continuation of the very small contango in both gold and silver that has existed since November. There are periodic but shortlived moves into backwardation during episodes of high price volatility but I have obseved no durable or sustained episodes during which gold or silver prices have entered into a level of backwardation that indicates imminent monetary collapse (by “imminent” I don’t mean immediate but rather an unavoidable event that requires immediate preparations). The major reason for the tight contango continues to be extremely low short-term interest rates, notably LIBOR. There is also an undeniable component tied to physical, and perhaps even incipient monetary, demand, but this “non-interest component” has actually been decreasing in importance after peaking in December. The importance of the “non-interest component”, however, may be showing signs of reversing during the past several sessions. I am very eager to update Metal Augmentor subscribers about this development in specific detail, hopefully as early as this weekend.

I’m going to wrap up for now but I do plan to post new material (including Part II of my response to Professor Fekete’s points about my basis analysis) over the next several days including the remaining installments of the videos for GSUL participants and updates for Metal Augmentor subscribers.

silverax Windbag Wisdom