Precious Metals

The Bank of England's (BOE's) ridiculous second 25 ton gold auction took place on September 21 ( basically giving it away at $255.75 within a few bucks of the 20 year low). It was so firmly over-subscribed to by a margin of 8-1, that it triggered the beginning of a powerful short covering rally. Within days, the IMF announced their alternative decision to outright gold sales, deciding to "re-value" their gold reserve from the $47 value it has been held at on its books to the current market price (out of thin air too, why can't I do that?) so they could lend the unrealized $2 billion gain to the 41 poor nations under the Highly Indebted Poor Country (HIPC) initiative. This will supposedly come from the "off-market" sale of $14 million ounces of gold, according to the IMF's Managing Director, Michael Camdessus. As stated last month, this accounting change will be leveraged to generate investment returns that will be used for debt relief. This seems to be tantamount to opening a whopper of a margin account!

This was indeed bullish news for the world gold markets, but it was nothing in comparison to what US investors woke up to on the following Monday morning (9/27), discovering that gold had soared $14 overnight in London! The 15 member European Union (EU) announced that they would limit their future annual gold sales to a total of just 400 metric tonnes per year over the next five years "including" the previously announced gold sales planned by the BOE and 1300 tonnes announced by the Swiss, which has yet to be approved by a Swiss referendum. This doesn't leave much gold for the other members to sell.

According to a question raised by Michael Kosares of , "If the World Gold Council is correct that signatory selling rights cannot be transferred to another central bank, what will happen to the price if Swiss voters fail to pass the referendum to sell their gold?." The answer would be obvious except for the fact that they would probably figure out a way for other central banks to sell in Switzerland's place. This new limitation on structured gold sales effectively places an acceptable floor of support under the market and changed the psychology overnight, removing the proverbial "Sword of Damacles" from above the market's head. This sent prices through the roof in Asia and Europe before we even woke up to the news and prices have not looked back with short sellers scrambling to buy in their bearish positions on every dip.

We had said on many occasions that while there was risk in ownership, there was perhaps even more risk in not being there when the turn came. Oddly expecting that one day we'd wake up and prices would be off the launching pad, not giving the uninitiated a chance of getting in at a reasonable price. This was, as it turned out, precisely what happened.

While not nearly as bullish as they were, our gold indicators still remain bullish overall and allow for higher prices to resume. The XAU managed to confirm a major bottom by closing above significant resistance at the May 6, 82.74 high, reaching a high at the next barrier at 92.72 before consolidating. Prices have backed off to a low near 76, but have so far found buyers on each attempt to sell off further. Support is right at 76, with more at the original breakout point at 72. A drop below this would force us to rethink the immediate bullish case, with next support at 68, 64 and 60. Resistance is at 82 and then at the recent high at 92.72. Any sustained push above this would confirm the new bull market.

After last month's casualty involving the demise of Martin Armstrong's Princeton Economics Institute along with his arrest for $1 billion fraud, new casualties are indeed emerging. The latest debacle isn't among the heavily leveraged speculators, although we think those announcements are also forthcoming. It was one of the heavily "hedged" gold producers that was a component of the XAU, Ashanti Goldfields. They had sold forward the majority of their future gold production most near the price lows. When gold exploded higher, it triggered a massive margin call, beyond what they could repay to settle it. They are said to be facing a $270 million margin call on a $570 million short position. This has created a newly perceived risk for other producers who have sold forward their future production, which many have done to keep their heads above water in recent years. Because of this newly perceived risk, the stocks within the XAU have been lagging the physical gold market because investors fear they may buy into the next Ashanti type over-leveraged margin call.

Market Vane's Weekly Survey of gold traders finally exploded from the depressed levels of past months, triggered by the overwhelmingly bullish events that followed the 9/21 BOE's foolish gold sales near the recent 29 year lows. Futures traders were most recently at 54% (after reaching 57%) bullish, up from the 13%, 12 year record low. Further bullish potential still exists and may extend itself over time because of the excessive period of pessimism that was endured. The 10/5 COT report shows speculators were running for cover, panicking to find the physical gold they needed to purchase in order to repay their bearish gold loans. This helped to fuel the violent rally that they created as part of the process of closing out their shorts. Speculators net positions are still net short -21,857 contracts, significantly less than their -62,910 net short position last month. Commercials reduced their record long positions accordingly to 12,398 contracts from 60,408 contracts before the fireworks began. It appears that the day of reckoning has arrived for the perma-bears.

Already high, one month lease rates spiked even higher to a $10 record before coming back down. This continued as supporting evidence that gold availability was getting unequivocally tight, as central banks had begun withdrawing from the lease market ahead of their big announcement. Until prices were much higher, this made it impossible for short sellers to find physical gold for delivery that would allow them to settle their bearish trades. We are certain that this will lead to more insolvency announcements.

Many of these recent dramatic events carry long term bullish implications because they change the focus of the central banks from gold lenders to gold investors. This makes higher prices in their best interests (where we thought they should have been all along). It is unlikely that such an explosive reversal from the depths of the depressive state of affairs of gold will be a short lived event. Indeed, such reversals have historically marked major turning points. The most recent example was on January 15, 1991, when the US bombing campaign against Iraq first began. Pessimism was high as was short interest with everyone in the world watching and worrying, betting that a furious bear market would continue. When the opening bell rang on Monday morning, the stock market was up and running and hasn't seen those lows again since.