"When misguided public opinion honors what is despicable and despises what is honorable, punishes virtue and rewards vice, encourages what is harmful and discourages what is useful, applauds falsehood and smothers truth under indifference or insult, a nation turns its back on progress and can be restored only by the terrible lessons of catastrophe." … Frederic Bastiat
Evil talks about tolerance only when it’s weak. When it gains the upper hand, its vanity always requires the destruction of the good and the innocent, because the example of good and innocent lives is an ongoing witness against it. So it always has been. So it always will be. And America has no special immunity to becoming an enemy of its own founding beliefs about human freedom, human dignity, the limited power of the state, and the sovereignty of God. – Archbishop Chaput
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The multi-decade bull market in US bonds is clearly over and with it comes an entirely new set of issues that the US government is going to eventually be forced to come to grips with. A monumental federal debt requires LOW interest rates to deal with the mathematics that can quickly make it completely unmanageable. Those days are now behind us.
Take a look at the following chart and you will see what I mean. I had expected that the long bond would find some buying support emerge near the intersection of TWO CRITICAL REGIONS. The first of these was a band of horizontal chart support near the 135 region. The second just so happens to be that region is also the 50% Fibonacci Retracement level of the rally off the secondary low in early 2011 to the peak last fall.
Guess what? The bond market collapsed through that level as if it did not even exist. Next stop looks to be the 61.8% Fibonacci retracement level down near 131 now that the bonds have CLOSED BELOW the 200 week moving average.
Safe havens bonds are now firmly out of favor with the view that tapering of the bond buying program of the Fed (QE4) will now begin as early as September of this year. Rising interest rates are working to bring the US Dollar into increasing favor among global investors as most countries out there with major currencies are no where near to a period of rising interest rates.
It does appear that we are going to be entering a period of rising stocks, rising interest rates and a rising Dollar, all at the same time.
Pretty remarkable isn't it considering that trillions of those self-same dollars have been created by the Fed over the last few years? It just goes to show that demand for the US currency is phenomenal mainly because demand for the other major currencies is rotten!
Never mind the growing number of part time jobs, nor the rise in the unemployment rate, all the market looked at was the headline number of 195,000 jobs created compared to expectations of 165,000 and it was pretty much baked-into-the-cake that the tapering was going to begin in September of this year.
That pulled the rug out from under both gold and the bond market as those markets plunged. Rising interest rates in what most investors believe is a NON-INFLATIONARY environment is serving to lure short sellers into gold and forcing an exodus among recent bottom pickers and even some long-time bulls.
As stated many times recently, gold is in a intermediate term bear market and as such, rallies are going to be sold by speculative forces until such time as the technical chart pattern changes.
I wish to remind readers of this site not to be sucked into taking aggressive long positions in anything gold right now unless you have deep pockets and can absorb further losses while you wait for the deflation/inflation psychology to shift. Trying to buy into a market like this right now is attempting to catch a falling knife - you are going to end up getting hurt.
One of the most important thing to learn if you are trading futures is that LEVERAGE can destroy you. Far too many of these self-appointed experts in gold, whether they be "analysts" recommending long positions based on their improper reading of that Commitment of Traders reports, or those who have gold to sell, simply do not recognize that the chart pattern in gold has shifted on an intermediate and shorter term time basis. When they glibly recommend long positions in gold, they are setting you up to get hurt badly when the trend reasserts itself as it is currently doing today.
If you are trading on the shortest of time frames (day trading) that is one thing as there will always be short term tradable bottoms as well as tops. However, to take a position in the gold futures market without a technical chart confirmation that the trend is changed is the same as having a financial death wish. Remember that....
Currently gold is holding above psychological chart support at the $1200 level which is near the cost of production. That level needs to hold or it will revisit the recent low near $1180. I have noted the extremely high volume day with ellipses. That area should attract buying if the bottom is actually in. We will see what happens.
The mining shares are also falling lower today which is serving to bring additional sellers into the Comex. Throw in the fact that the US Dollar is absolutely SOARING and proving to be the King of the Hill among currencies, gold has its work cut out for it if it is going to start any sort of SUSTAINABLE rally to the upside. For right now, gold will have to clear and STAY ABOVE $1250 - $1260, preferably on a weekly chart, to denote a more lasting bottom.
Once upon a time in the West, We Dig It UP Mining, hedged or forward sold some of its expected gold production in order to mitigate price risk and to ensure that it captured reasonable profits on at least part of its production.
Then came the bull market in gold starting in 2001. We Dig It Up was nonplussed to say the least when it saw what its competitors' stock prices were doing while the price of gold was rising. Theirs' were exploding higher while its was languishing. As a matter of fact, New Kid on the Block Mining was bragging about its disdain for hedging while We Dig It Up Mining spend most of its stockholder meetings explaining why it was engaging in this obsolete strategy.
Eventually, threats from disgruntled shareholders and loss of market performance, were enough to convince the Board of We Dig It Up to abandon the practice of hedging altogether and join the crowd.
That is basically the way things have been since early in the last decade, until now!
What do I mean? Simple - Mining companies are now being faced with life and death decisions when it comes to the well being of their business. No one is quite sure how low the price of gold may or may not go but one thing they are certain of; gold down at current price levels means many miners are not going to be able to profitably (that word is key) dig the ore out of the ground for processing.
Put yourself in the seat of the CEO's and CFO's of the miners - Your life's blood is gold. If you can dig it out of the ground and make a profit, enough to pay your bills and reward shareholders, you can plod along, watching expenses, etc. while you wait for the price of gold to move higher. But when that will happen is unclear right now. So you now have a new risk that you have not faced in OVER a DECADE - namely the risk of price falling so low that you can no longer mine it profitably. Seriously, at what point during the last decade did anyone even dream of not being able to dig gold up profitably given the state of a nearly continuous rise in its price. So what do you do? I think the answer is self-explanatory - you have to lock in a selling price for gold that GUARANTEES your business a profit even if the price for the commodity you are mining were to fall even lower.
Welcome back to the world of risk management and HEDGING for the mining industry. That is what I believe transpired this past week. Many mining companies began to re-examine their swearing off of hedging or forward selling and moved to take steps that would guarantee their survival even if it meant leaving some potential profits on the table.
I have come to this conclusion based on my analysis of this week's Commitment of Traders report. I would like to point out here that Eric King and I discuss this in great detail on this week's KWN Markets and Metals Wrap so I strongly urge the reader to tune in to that audio interview when it is posted tomorrow (Saturday).
I did want to provide some graphics however to go with that audio interview.
Here is what I believe the trigger point was for mining companies to begin hedging once again. In looking at the following weekly chart of gold, note that area in the red rectangle that I have noted as STRONG SUPPORT. Keep in mind that although gold had been in a strong downtrend, it had not fallen below the $1340 - $1320 level since April of this year. As a matter of fact, that had marked the low price for gold this year. Strong buying, reports of record offtake and long lines in Asia at coin shops had come every single time price moved to this region.
Now, when a market has been in a bullish trend for as long as gold has been, it is very difficult for many people to believe that the trend has changed. After all, that is what gold had been doing for over a decade; it had been retreating in price only to find strong support zones and then rebound and go on to make new highs.
This is why many of my friends in the gold camp continue to miss what has been happening in gold. They are not looking at the price chart objectively but continue to call for bottoms waiting for gold to slingshot back higher JUST LIKE IT HAS DONE FOR 10-11 years. Guess what? It did not do that.
I think this is the same problem that afflicted many of those who make decisions at the mining companies regarding risk management. That phrase, "risk management" has not really been needed in a continuously rising gold price environment. All of a sudden however, all of these mining company decision makers sat and watched gold CRASH through that floor of support in price and then proceed to drop over another $100 lower. Yes, it bounced today and yes, maybe the worst of the selling is over, for now, but as a mining company, can you really take the chance that the price of gold is not going to drop lower?
Good prudence calls for some risk mitigation and that means you lock in profits on SOME gold produced when the market gives you an opportunity to do so. This is one of the reasons I expect to see rallies in gold being heavily sold - hedging programs are going to be back in vogue.
Back to the Commitment of Traders report however from which I have deduced my theory. We have come to expect to see, each and every week, as the price of gold descends lower, the Commercial category, composed of the Producer/User/Processor/Merchants reducing the number of shorts as the price moves lower and increasing the number of longs. The opposite is true of course for the hedge fund category. They of course liquidate existing long positions (sell out) and institute new short positions (sell) as the price moves lower. That has been a very reliable pattern for most of the last decade in gold.
What this pattern fails to take into account however, is the fact that hedging fell out of favor among the mining companies a decade ago. Remember the grief that Barrick caught back then???? As a result, we have been accustomed to seeing the Commercial category as being primarily a proxy for the big Bullion Banks as we have not had to consider hedging of any large size by mining companies to deal with.
Nonetheless, it is in this category, the PRODUCER, that any gold mining company wishing to use the futures market to hedge is going to be placed for classification purposes. We might see some of that indirectly through the Swap Dealer category but let's let that go for right now and focus on the former category.
IN this week's COT report, we witnessed a departure from the norm that I just mentioned above; namely, we did not see the Producer/User/Merchant/Processor category have the normal substantial shift in their overall net short position. Instead, what we witnessed was an increase of 8,754 new longs (futures and options combined) but we also saw an INCREASE in the BRAND NEW SHORT positions of some 7,151 contracts.
The pattern since the middle of May has been a steady decrease in the number of short positions in this category which is why this week's jump of over 7100 new short contracts caught my eye. In looking over the price action and considering the fact that the recording period for this Friday's release of the COT report included the week in which gold crashed through that critical downside support level of $1320, I am surmising that was the straw that broke the proverbial camel's back and has sent some of the mining companies back into the hedging business. In short, I feel very strongly that miners are now getting downside protection in gold to ensure that they can mine their product at a profitable level and SURVIVE!
Why this has caught my attention, and quite frankly I missed it back in early April, was that at that time, the $1525 level had come to have the same significance from a technical chart perspective as the $1320 level had this week and last week. If you look at the chart of outright commercial short positions, you can see that it has been steadily declining along with the price of gold for most of this year. There are brief periods however when the number of shorts has increased in this category. The first one occurred in early April when we had a huge downside break of chart support at $1525. I believe it was at this time, that some of the mining companies began to quietly institute some hedges. Not wishing to get the word out for fear of the stigma of hedging in the gold investment community, they did however begin showing some signs of worry and decided to get some minimal downside price protection.
We then had another spike in the short positions from late April into middle May. That was associated with the rally back up from below $1350 where price come close to reaching $1480. I have no doubt that was bullion bank fresh shorting but now in hindsight it might also have included some hedging by miners.
Of course we have just covered the reason I believe to be behind this week's spike higher in the number of commercial short positions.
I tend to write quite often that one day or one week for that matter, does not a trend make so I want to watch things proceed from this point and decipher price action further in conjunction with subsequent COT releases, but when I read stories in the financial news wires that mining companies are using a word that had been considered, taboo, for most of the decade, my eyes and ears perk up.
From what I can glean from this week's report, in combination with the price action and news stories, I think we can safely assume that hedging is back in vogue and will be until gold gives some evidence that it is ready to move sharply higher once again.
I wish to remind the readers that I live in the world of commodity futures and thus am not an equity expert nor do I hold myself out to be one. I would say however that it might be useful to long term holders of these mining shares to call their Investor Relations department and see if they will discuss whether or not the company might have instituted some hedges and put in place some risk management. At the very least, it would be enlightening. Quite frankly, any mining outfit that did lock in a selling price through the use of forward contracts or through hedging in the futures market, especially back in April of this year, is going to look like a genius to its shareholders right now, given the carnage to the gold price....
Dow Jones is reporting that some very large bets on a rise in the gold price from current levels are currently being made in the largest gold ETF, GLD.
Gold has dropped to within spitting distance of support near $1150 before rebounding higher as it was led up by Silver in today's session.
The catalyst seemed to come from the Consumer Sentiment number which was quite strong, surprisingly so. Under recent conditions, this sort of number would have been expected to generate strong selling across the precious metals sector as it further feeds the theory of tapering to begin earlier than expected.
What seems to have happened however is that when the wave of selling did not materialize, bottom pickers, as well as extremely profitable shorts, decided that was a signal to either book some profits or establish some new long positions.
Further complicating matters - it is not only the End-of-Month positioning and book squaring that is at work but also the even larger End-of-Quarter movements. Large investment funds and hedge funds will generally square their books especially after amassing such large profits on the drop in gold and gold shares over this past quarter. That generates another wave of buying.
I prefer to see what gold does next week as we start a new quarter to get a better read on whether or not we have established a lasting bottom. I still expect rallies to be sold in this market but from what level is a bit unclear. A second test of the overnight low down near $1180 would be most revealing as to whether the carnage in this market has finally come to an end.
The mining shares are quite strong today and continue to build on yesterday's mild gains. That is a good sign as they led this market lower and I believe will lead it higher when a permanent bottom is finally forged.
Take a look at this quarterly gold chart. This appears to be worst quarterly performance for gold in history!
If we ignore that spike high to $1900 and draw out Fibonacci retracement levels off the triple top at $1800, gold has bounced off the 38.2% Fibonacci retracement level of the entire move beginning back in 2001. That level is near $1200 (1207 to be exact). That is constructive but quite frankly, this market has been beaten up so badly that a bounce of some sort was way overdue. I prefer to err on the side of caution as gold is entering a seasonally slow period for demand with the summer doldrums coming up. That, plus the fact that we have a big June payrolls number coming up soon and if that thing comes in stronger than the markets expect, it is going to further feed the TAPER psychology.
Let's be clear - all the way down we have had bottom callers and none of them have been correct. Eventually they will get it right but as the old saying goes, even a stopped clock is right twice a day! Let's monitor the subsequent price action for a while before getting too dogmatic. Remember the trend in gold is now down on the shorter term charts so specs will be looking to sell rallies unless something changes on the QE front or the psychology in the market changes to one of expecting a pickup in inflation.
There is no need to be a hero and try nailing an exact bottom. It is next to impossible to do that on a consistent basis. Traders do not need to call exact tops or exact bottoms for that matter. All they need to do is to spot the change in trend and position themselves to take 60-70% out of that trend to make money. Remember, Bottom pickers and Top pickers eventually become cotton pickers!
We are seeing a snowballing effect now occurring in gold as even long term holders of the metal are getting washed out. As the metal moves lower, those who are still long are eying trendlines and support levels and are growing increasingly worried that what is left of any profits they might have in gold, since coming in back in 2010, are disappearing. That is creating forced selling further emboldening the bears who are now pressing hard on the market.
I mentioned in yesterday's post that the round numbers such as $1400, $1300 and $1200, do not seem to be holding very well on the way down but are acting much better as resistance levels on the way back up. That is proving to be the case with the $1200 level. Gold has dipped down below there twice in the last two sessions (previous session and current session). Downside momentum is favoring a push towards $1150 at this point unless price can QUICKLY recover $1200 and push away from that level to the upside.
See that previous post for downside targets....
I wanted you to notice on the weekly chart that this particular indicator that I employ has not been this oversold since the very beginning of the bull market in gold all the way back to the year 2001. As of now, I do not yet see any signs that this indicator is leveling out or is losing downside momentum. That translates to the odds favoring further downside before this wave lower is exhausted.
With no signs of inflation in the eyes on most investors, with rising interest rates and with little to no focus on the long term structural problems besetting the US (ballooning deficits and an out-of-control growth in entitlements, not to mention sovereign debts fears out of Europe receding from the front pages, gold is struggling to attract any buying among speculators.
I suspect that when price has fallen far enough however, Far Eastern buying by Central Banks and large long-term oriented interests from that region, will abruptly arise. We will continue to monitor the price charts for evidence of their footprints. For now, specs continue to unload the metal.
Let's watch the HUI however to see if there are any signs that the selling in the mining shares might possibly be coming to an end. Remember, the shares led the metal lower and will probably lead the metal higher. One day does not however make an end to a strong trend.
The rate of descent in the mining shares is remarkable. Rarely does one witness a collapse of this magnitude and severity without some sort of period of consolidation. It speaks to me like a final washout is underway, even of the most die-hard, long term bulls.
In a period of only 9 months, the index has lost 60% of its value. As stated before, the damage inflicted on the owners of these shares, both financially and psychologically, has just about guaranteed that the vast majority of those who bought them as a hedge against expected inflation will never again in their lifetime come back as buyers in this sector. If they do come back to gold, it will be the ETF, GLD, or some other entity but it will not be mining shares unless management makes it attractive through dividends or some other novel method to own them.
In looking for a place on the chart where the POTENTIAL for a stem in the bleeding can occur, I have noted two different sets of Fibonacci retracement levels. The first set takes the entire decade long bull market and the second takes the rally off the 2008 low, prior to the inception of QEI.
Note how close the various Fibonacci lines from both sets (red and blue lines) come closely together at key areas. Notice also how both sets have failed to offer any support.
We are now down to a region where we are running out of support levels. I have noted the next one which starts below the 200 level and extends to 186. If that cannot hold, we are back to where the index was at the bottom in 2008, near 159 - 160.
Several readers have asked me where I think this move lower in gold could finally exhaust itself. That is a good question.
All I have to go off of is the chart plus the knowledge that various costs of production for gold continue to surface from the investment houses. Some put the cost between $1200 - $1250. I have seen other estimates taking that down to $1150 or so.
The point is that gold is nearing levels that are going to make it extremely difficult for many mining operations to continue at any sort of profit. Already I am getting reports from S. African miners that are in trouble.
As I mentioned in a previous post, mine shut ins will only begin if gold moves to these aforementioned levels and stays there a while. If it just hits those levels and rebounds higher, the shut ins will not take place. I do believe however that we are not currently in an environment in which gold is going to violently rebound higher. Barring some unforeseen event, there is simply no reason to hold the metal especially in the face of rising interest rates and a widespread belief that inflation pressures remain subdued. Throw in the fact that the US Dollar is very strong, and that means gold is going to have a difficult time mounting any sustainable rally in price.
All this being said, the chart does provide us some interesting information when tied in with those cost of production estimates.
Notice the lines that I have marked, "SUPPORT" on the chart and note the price levels that they come in near.
The first one is just about at the $1150 level. That number is mentioned above as one of the costs of production. Then you have a major 50% Fibonacci retracement level coming in near $1090 and another level of support near $1050.
I see things as follows: Gold has round number psychological number support at the $1200 level. Thus far in this meltdown, those round numbers have not been very good at holding on the downside; rather they have served fairly well as selling points for rallies.
If $1200 fails, then you have support down at the cost of production near the $1150 level. Seeing that markets tend to always overshoot prices because of margin calls and other assorted technical factors, if $1150 failed to hold, you could see another $100 or so drop in price. That would take gold into the next support level noted below the 50% Fibonacci level which is $1050.
Let's just say that I do not believe gold prices would stay down below that level for any length of time. I remember what seems an eon ago when it was buying from the INDIAN CENTRAL BANK that took the price of gold through the $1000 level. It never saw that level again.
My thinking is that Central Bank buying will be quite intense should gold ever get to that level.
My view is that $1050 would represent a buying opportunity, should gold get down that low for long-term oriented investors. Remember, this is for investors, not traders.
Obviously any production cutbacks would impact the supply side of the supply/demand equation only. We still need to see how demand will shape up as price descends lower. Demand must exceed supply if price is to rise.
