Critical updates - Gold and Silver

It has been a while I have written anything on my blog. A friend wrote to me for some updates and I have decided to put down some of my key thoughts.

Gold and silver have gone up for a few months. I turned bullish around 1580 in the beginning of August 2012 and has been adding positions since.

Then came all the printing of money worldwide - with Europe and USA putting no limits on adding liquidity to the market to contain the negative economic developments around the world. China and Japan are joining the currency wars. My ideas that I got from reading "End Game" by Mauldin and "Curreny Wars " by Jim Rickard are playing out in high definition. I also read another book "The ascent of money " by Neil Ferguson recently and it certainly added to my understanding of what is going on. As Mark Twain said, " history does not repeat itself but it rhymes"

According to all logic and fundamentals, lost of value in currency should translate into increase in value for sound assets and commodities.

But strangely, during this period, we have seen that oil has not participated in the bullish scenario. It has actually dropped 13% and acting bearishly. To this, I can attribute to some increase of supply over demand and the lower probability of a war with Iran since they are imploding themselves with the imposed sanctions working well.

Also, we have seen a 44% decline in coffee in the past 14 months, 25% in sugar prices, and a decline in copper price. One possible explanation is the debt overhang is still not resolved and deflationary forces are still in play. If that is the case, there will be more easing as indicated by the Fed.

Gold and silver did react positively but has seen been contained at $1800 and $35 respectively

What is happening? Lets look at some interesting Commitment of Traders (COT) data. A good commodity trader always study the COT data that are released every week. 

GOLD

Date      Price closed     Commercials shorts              Net short ratio

8/14      $1602               291358                                  1.98:1

9/11      $1735               380,239(+30%)                       2.66:1

10/2      $1775               405,520 (+7% after QE3)          2.98:1

SILVER

Date      Price closed     Commercials shorts                   Net short ratio   

8/14     $27.85               71,199                                   1.49:1

9/11     $33.57               79,478(+11.6%)                    2.47:1

10/       $34.67               93,628(+17.8% after QE3)     2.62:1

The interpretation is that the few big banks ( JPM, HSBC, GS, etc ) are continuing to pile into the shorts despite the general bullishness of speculators and hedge funds. They are taking huge gamble to double down. This the cardinal sin of a professional trader.

It is concluded by Ted Butler, a long time metal COT analyst that JPM now holds short of 34,000 contracts which is equivalent to 170,000,000 ounces of silver or 20% of world's production for 2012.  If you add the 4 banks together, they hold over 50% of the shorts. It was such a concentrated position that in a normal market, such players will be persecuted. But a ruling came out last week from the courts and throw out CFTC proposition for setting position limits on trading of silver. 

I used to run an internet trading platform in a stock exchange. Such position concentrated by any stock exchange and players will be persecuted or stopped but not in America. Strange?? Is it true that the bankers  ( or banksters ) are so powerful that they have all pervasive influence on the government admin. and legal systems? How I wish I can take such risky gamble without worrying on any downside.

In end Feb this year, this has worked very well for them. There was a dramatic decline the metal prices after that. A lot of fear still exists that history will repeat again. 

So now we understand why the $1800 and $35 gold must be capped. It is a multiple tops. Psychologically, it is very bad for the shorts. If it breaks, the metals are going to shoot up. 

What is effectively done is to stop the metals from breaking the technical levels by all means even taking double or triple the risks.  If they succeed like in Feb. this year, they will make a lot of money. If they lose,  it will be a disaster.  But no worry, the tax payers of America will bail them out again as they are "too big to fail"

Watch out for this level. There is still a probability that it will break up for the following reasons:

Fundamentally, gold and silver are still the best store value with all the money printing around. It is actually very bullish. I have seen many instances of commercials trying to cap the top but eventually they will fail again.

Technically, the precious metals have not lost its momentum. It is over bought but still in the bullish regression channels. Until it breaks, I continue to stay bullish. 

It only needs a few factors that will break the tops.  If the traders from China comes back from holiday and starts buying gold and Spain agrees to a bailout in the new 1-2 days, the commercials will either have to cover their shorts or continue to add to it until it breaks. Eventually, if they fail, it will be a breakdown of the system.

But what to do if it moves bearish and against my positions? It could be fast and furious as a lot of speculators and weak holders will bail out and stop losses will be triggered. It can still breakdown to <$1600 for gold and <$30 for silver although the probability is low. 

I am not taking chances. I will add puts and SCs to my position ( currently naked after enjoying >25% gains in 1.5 months ) once it breaks the bullish channel technically. I will not trade against the general trend. The ability to spot a reversal is very critical. I have my methodology but it is probably only 50-60% accurate which I am satisfied. With my trading system, the ability to spot reversal at these probability levels will be enough for me to make good money.

Effectively, I will bailing out until the situation stabilized. If am whipsawed, I will be taking profits after a good run. I will continue to add on positions again once the bullish trend resumes.

Longer term I am still very bullish.