Fear Returns to Gold
The markets (well, at least some of them) appear to be returning to the fearful reality that the global recession has no end in sight. The main beneficiaries of this realization are the dollar and gold and thus it should be no surprise that both are rallying strongly in tandem today. I have a suspicion, however, that gold will not be able to capitalize on the fear trade as successfully as it did earlier this year
Meawhile, silver is merely going along for the ride. The rise above $12 was technically positive especially since silver managed to spend just a few hours below that level, but the shiny metal seems to lack spirit on its rebound.
Other than the lackluster rebound in silver, my reason for being less than excited about gold and silver in the near term is that for the first time in quite a while (late January to be exact), both the gold and silver ETFs, GLD and SLV, are trading at or below par. A discount to NAV (or what I call contango) in the ETFs effectively means that physical investment demand is not very widespread at this point. By contrast, the previous fear-based rallies in gold and silver were accompanied by strong premiums (backwardation) in the ETFs. Could this time be different? Certainly, but the odds aren’t good in my opinion (or the opinion of the ETF basis).
Looking at the industrial commodity kings — oil and copper — they are both weak today with reality setting in. Oil has still not managed to convincingly cross the $54.60 line in the sand although it has managed to retain a contango in the NYMEX WTI crude futures significant enough to ensure that stored supply does not flood back onto the market, which would certainly crash prices. Copper got stopped just short of the $2.25 level, and while it could still top out somewhere between $2.25 and $2.50, the action in the copper stocks over the past two days is telling us that a sharp decline could be dead ahead.
I’ll have much more to say in the next few days as I am back in action after taking care of some other commitments last week.
“Other than the lackluster rebound in silver, my reason for being less than excited about gold and silver in the near term is that for the first time in quite a while (late January to be exact), both the gold and silver ETFs, GLD and SLV, are trading at or below par.”
I think this analysis is backward looking. How good of a predictor of FUTURE prices has this indicator been? Judging from silver’s performance at the end of January (a rally of about 25%), I’d say not very. I really enjoy reading your commentary, but honestly you’re short term calls on the direction of gold and silver haven’t been very good.
You are kidding, right? I called the strong rally from the $850 level in late January based on the ETF basis readings, and previous to that I called the strong rally last September using the same readings. I also mentioned in both February and March that the ETF readings very equivocating and that it probably meant a top or range trade. The ETF basis is not going to get every move right, but when it does the indicators appear to be quite unmistakable and they do occur in advance, not “backward looking”.
Now let’s look at all the “experts”, most of whom have been saying “gold and silver to the moon” not only the past few months but almost incessantly. I suppose you think their calls are very good even though they are right only insofar as a broken clock is right twice a day.
True the massive drop in gold that I cautioned about never materialized (by the way, this “call” was not based on the ETF basis at all) but I clearly stated the odds of that were not very high, and my point was that the risk to traders and speculators was significant (and it still is).
GEAB No.34 predicts U.S. default this summer. Trading paper metal is ludicrous–I did it for 30 years; closed my MF Global Vancouver account last summer. That office closed end of last month. Time to get real.
@silverax
Maybe I am misunderstanding something. You say that the last time SLV traded below par value (which you imply is bearish) was in late January. Despite this, silver had a strong rally in February. Clearly in this instance SLV trading below par value had no predictive value. What should it this time?
“Now let’s look at all the “experts”, most of whom have been saying “gold and silver to the moon” not only the past few months but almost incessantly. I suppose you think their calls are very good even though they are right only insofar as a broken clock is right twice a day.”
You suppose wrong. Instead of the get-rich-quick-try-to-hit-it-out-of-the-park-trading-options strategy, I have been writing SLV options against my physical holdings when silver rallies. It’s a nice way to earn “interest” on my silver and I’ll bet the strategy works out much better in the long run than pretending I can predict every fluctuation in the market.
You are indeed misunderstanding. SLV traded ABOVE par value in late January just a couple of days before gold and silver broke out. SLV is now trading at or below par value which is an indication of softer prices ahead. Softer doesn’t necessarily mean lower, it just means the likelihood of a strong rally is low. Of course if SLV trades at a significant premium again (above par value) that means prices should be stronger in the immediate term. It could happen tomorrow, next week or next month, and it is also quite possible that the ETFs may not be good indicators the next time around and so it is always a good idea to consider a number of different factors.
There is certainly nothing wrong with writing calls against a physical position — it is the way many professionals make their nut in the market and Professor Fekete states this is a common practice by “bulls in bears’ skin” with gold and silver as well — but the risk is not finite and I would not suggest this to someone I don’t know. Also, one mistake and you give up in one trade what it took ten trades to earn. Dealing with this requires a particular type of mindset whereas the “get-rich-quick-try-to-hit-it-out-of-the-park-trading-options strategy” can often be less trying on the soul.
Jeff S. you are fighting a uphill battle with SilverX. Although sometimes his commentary may have a bullish tone. He always injects negativity into it as to why gold and silver show go down. Basically his tone is bearish on gold and silver. Frankly I feel he bring nothing to the table. He pretty much refutes any bullish scenario in gold or silver. I post and come to the blogg because I enjoy reading information.
@silverax
Actually I don’t believe I am misunderstanding. Silver was rallying nicely since the middle of January, before SLV was trading above par. So the backwardation only occured well into the rally. Doesn’t sound like a forward looking indicator to me.
So let me see. You are saying that just because a single factor cannot predict the entire rally from bottom to top and back to bottom that it should be thrown out? There is nothing that can do that. The SLV basis has its use and I have frequently noted that it is limited. The fact is that the rally in both gold and silver accelerated after SLV traded at a premium, which happened before the breakout. In other words, SLV was saying to trade the breakout instead of bet against it. You would have been creamed had you sold calls just above the breakout point expecting that it would fail.
@silverax
I only sell deep out of the money calls, so I wasn’t creamed at all. SLV has way bigger call premiums than GLD, so you can make a decent return selling options that have little chance of hitting the strike price. I may only make an extra 8% to 10% annualized using this strategy, but I can live with that.
I looked at the COT report today and I would say it looks very constructive for silver, less so for gold.
The COT commercial net short silver position is very close to the November lows. Gold net shorts could drop much more.
@Silver
It appears you are mistaking bullish and bearish for balanced, which is a common if amateurish mistake. I will never be a brainless cheerleader for gold and silver, there are plenty of those already. You are right that my tone on balance has been bearish with respect to TRADING or SPECULATING since the middle of last July with the exception of some interludes and specific trades. Lo and behold, what have gold and silver done? Yup, they are DOWN since last July. At the same time, I have pointed out on a number of occasions when I thought accumulation (especially to build a core position) should be considered.
If you are making 8-10% annualized you might be taking too much risk (going out more than 1-2 months), and the problem I see is the day when Israel bombs Iran’s nuclear facilities (or some similar misadventure takes place), you could lose several years’ worth of profits if not more.
@silverax
You really think silver is going to double overnight if Israel bombs Iran? I doubt it. Can you point out one geopolitical event in history that had that type of affect on precious metals?
As for taking too much risk, I only sell calls after silver has had a significant rally, ensuring that I will make a nice profit even if the strike price is hit. If silver doesn’t rally I won’t sell calls at all - so it’s possible that my return could be 0 in a given year. Still, I think 8% - 10% is a fairly reasonable target, and only risk I bear is an opportunity cost.
On Friday I bought back my July $16 and $19 Calls that I sold in March. I will sell again when silver rallies 20% from its last bottom.
You seem to have a reasonable, cautious approach and I would still say that 8-10% annual return is very aggressive. If you can achieve that over the long term, you should charge some serious money to teach others how to do it. Plus I assume you are not doing this with the core 5-10% physical position that serves as insurance? And no, silver will probably not double overnight but it could go up 30-40% with lots of volatility to follow. I suppose your losses on sold calls would depend on how far away and out of the money you wrote them. The 1973 oil shock and the sequence of events in 1979 and 1980 created substantial volatility in gold and silver along with a confluence of other factors that bear similarities to today.
@silverax
“You seem to have a reasonable, cautious approach and I would still say that 8-10% annual return is very aggressive.”
I’ll let you know how it goes. And no, I don’t sell calls against 100% of my holdings.
That’ll work well until it doesn’t work anymore. Then you’ll be broke. Sorta like selling credit default swaps at AIG.
@skunky
“That’ll work well until it doesn’t work anymore. Then you’ll be broke. Sorta like selling credit default swaps at AIG.”
I assume you know what a covered call is, so you must have missed the part about my option writing being backed by physical silver. I wouldn’t dream of writing naked calls.
Funny how precious metals seem to be perfectly tracking, almost minute-by-minute, the inverse of the stock market:
http://finance.yahoo.com/q/bc?t=1d&s=SLV&l=on&z=m&q=l&c=&c=%5EGSPC
For me, I have reduced all this madness down to one simple premise. Whenever TPTB lose control of their paper-money-control-paradigm GOLD will indicate it and blast off to heights unknown.
As such, Gold is the only metric I watch anymore.
In advance of gold, the gold basis should “blast off”.
@silverax
Speaking about basis, the contango in gold and silver is very small; a few dollars for gold and a cent or two for silver.
A small basis is natural based on the fact that short term, “risk free”, interest rates are very low. If and when interest rates rise and the basis refuses to move further into contango, we will have something to talk about.