Near-Term Caution on Gold

Silver, mining stocks and futures-market positioning say gold's run might dip near term...

The LARGEST of the large gold and silver futures traders in New York significantly increased their collective net short positioning going into the US Thanksgiving week, a week of lighter than usual liquidity, writes Gene Arensberg in his Got Gold Report for the Gold Newsletter.

Comex commercial traders boosted their net short positioning for gold – the number of bearish contracts they hold as a group minus the bullish bets – by a large 24,558 contracts as of Tuesday, November 24, according to data released by the Commodities Futures Trading Commission (CFTC) on Monday, November 30.

At 306,104 contracts net short, the net short position held by traders the CFTC classes as "commercial" for gold is at a new nominal record.

On the surface that suggests that the largest gold hedgers and short sellers are once again taking a "goal line stand"...or at least employed a "prevent defense" as gold approached the $1,170 level. Indeed we have to note material and determined "opposition" to $1200 gold and $19 silver.

Interestingly, as the Comex commercial traders were stepping up their gold short positions, their colleagues, commercial traders on the Intercontinental Exchange or ICE, were apparently heading in the opposite direction with their US Dollar positioning. Despite additional weakness in the greenback, the "ICECOMS" ended the reporting week net short the buck for the first time in months.

Based on a preponderance of all the indicators in our gold and silver universe, we have adopted a cautious, neutral bias for the first time this year, for gold and for mining shares in general. Our bias remains cautiously bullish for silver, mainly because it remains strongly undervalued relative to gold.

We have moved our short-term trading stops to their highest, most cautious settings as of Friday, November 27. We have also employed partial hedging via inverse Gold ETFs, albeit with extremely tight, micro-loss stops in place.

Out of an abundance of caution we have also "harvested" some investing/trading "ammunition" from ultra high-flyers and offsetting laggards in an effort to build up the "opportunity arsenal".

With gold having just traded as much as 23% above its popular 200-day moving average (Wednesday November 25), and with the large, well-funded mining shares refusing to "answer" the last moves higher...and with silver also having refused to echo gold's remarkable move into nominal record territory...our antennae are up and so then are our defenses.

This week we noted continued positive money flow in many Gold ETFs. Once again we see significant positive money flow into the leading US silver ETF, which has added over 660 tonnes of new silver in November and over 2,600 tonnes this year.

Gold ended the holiday week in backwardation on the Comex futures markets, with the cash price actually higher than the front active contracts. Not so for silver.

Arguing in the opposite direction, as the buck fell again, ICE commercials actually went from net long to net short the greenback! Well-financed mining shares were flat for the holiday-influenced week. So no help there.

In short, we urge caution for short-term traders. Caution flags are flying. Please do not confuse that with an outright sell signal. If our short-term caution proves unwarranted, we want the opportunity to stay in the game (in the trade), thus, instead of just hitting the red (sell) button we move stops up to our tightest of tight settings. If a material precious metal smack-down is indeed in the making, we'll be watching it from the relative safety of the sidelines pronto.

We're cautious, but we will let the Trading Gods decide whether this is where we heave ho or get to stay game on with our short-term gold and silver ETF and futures trades.

And with our short-term caution firmly in mind, we reiterate our longer-term view here at Got Gold that the world will most likely continue down a path of fiat currency debasement, weakening confidence in all fiat currencies, coupled with incessant official meddling and interference. We see the setup as long-term very bullish for gold metal and extraordinarily bullish for silver looking well ahead.

We see nothing which promises to reverse the current flight of wealth out of paper and into real money.

For the meantime, silver may not be answering gold like it should, and that is certainly a reason to be short-term cautious, however it is clear that money flow continues to be positive for the second most popular precious metal. We continue to note much tighter spreads between the SLV silver ETF share price and the implied Net Asset Value per share during pullbacks for silver. Collectively investors are apparently still waiting for dips to buy more than not.

Arguing with what some analysts have suggested, SLV seems to have no trouble adding silver metal when the spreads tighten (when we would reasonably expect there to be additions to the metal holdings). Indeed, for the month of November, SLV added a little over 660 tonnes of silver to its holdings.

For all of 2009 thus far SLV has added a net 2,611.80 tonnes of silver to its holdings, an increase of 38%.

As long-time readers of the Got Gold Report know, SLV now holds a goodly amount of silver more than the amount called for in its custodian agreement with J.P.Morgan Chase, London.

Although the managers for SLV have yet to file documents with US regulators the SEC amending the current custodian agreement or announcing a new custodian or sub-custodian (and the amount of silver which the new agreement might indicate is available to SLV when it needs more), the current custodian is apparently able to supply enough metal for SLV's current needs.

We expect that soon after BlackRock's purchase of the iShares product line closes and is funded, we will likely see such an amendment to the SLV custodian agreement. We will comment on it then. Meanwhile, we are advised by people who absolutely know the status of silver availability in London that there is not currently any "shortage" of good-delivery bar silver. Most any London-based silver ETF should have no difficulty finding the silver it needs very near term.

Having said that, at now just over 302 million ounces held by SLV alone, some significant fraction of the available bar silver in London has been removed from the total amount available for all trading purposes. In other words, when we do finally see the surge in silver demand we have been expecting, there is a good deal less of it to satisfy that new demand.

Each thousand tonnes put away globally by all the silver ETFs, pools, funds and trusts reduces the available-for-trading bullion amount, hastening the time when we might see a sure-enough demand-critical-mass-event for silver similar to the one we witnessed in 1979.

We don't know precisely when, but we continue to believe that it is merely a question of time before we see a silver supply squeeze of equal or perhaps even superior amplitude to then. (If the world manages to hold things more or less together.) In our opinion, harsh dips for silver are to be bought rather than rallies sold into for our longer-term minded traders.

If our view is correct, then it would not be at all surprising to see silver trading well above its 1980 nominal highs near $50 the ounce in the not-too-distant future. It is difficult for people to grasp just how much less actual silver bullion metal exists compared to what was available during the last physical silver squeeze 29 years ago.

Sooner or later that will change.

As for gold – and as it has for several weeks – the market saw Gold Futures end last week in backwardation, where the cash or spot price was higher than the front active contracts.

Cash gold closed the holiday week at $1177.79, which was $3.59 above the December contract and $2.29 over February. The spread between cash gold and the December contract actually widened since our last full report two weeks ago when it was then $2.50.

Backwardation is rare and unusual in the metals futures markets. Backwardation suggests that demand for physical metal is immediate and material. Unlike gold, cash silver finished the week almost flat with the expiring December contract not technically in backwardation, but with the contango on the futures "strip" continuing to be as thin as the business end of a razor.

As we have said previously, while backwardation by itself does not guarantee that the metals will advance in price, most analysts and traders view backwardation as a much more bullish than bearish condition.

The Gold/Silver Ratio (GSR) however continued to warn last holiday week. As of Friday, November 27 the GSR stood at 64.39 ounces to buy one ounce of gold metal. A rising GSR is a bearish omen and vice versa. As we said two weeks ago in the last full report:

"We are forced to pay attention to this signal now, since the GSR has not corrected back lower. A rising gold/silver ratio is not just a metals market signal. Many traders use it as a canary-in-coal-mine gauge of overall market confidence. As of this week confidence is weakening if the GSR is any guide. Therefore we have taken more aggressive defensive action and suggest everyone keep an eye on this important indicator.

"Nothing says that the GSR cannot correct back lower right away and by doing so allay our concerns about it, but until the GSR is heading south again our antennae are up and our defenses are raised. Perhaps stating the obvious, as of today we see silver as very strongly undervalued relative to gold..."

The large, well-financed mining shares have once again stalled when compared to the performance of gold metal. With gold printing yet another new nominal all-time high some $160 higher than the May 2008 $1033 interim pinnacle, we have to note that the HUI was balking just under the 500 level. With gold 16% above its May 2008 turning high, the HUI would sill have to advance more than 9% higher just to equal its May top in the 519 arena.

Perhaps it is asking too much for mining shares to be as robust now as they were then, in early 2008 before the collapse of Lehman, Bear, AIG and the near total collapse of the global financial system. Perhaps, but we also have to note that we viewed the action then as a warning because mining shares did not seem to be fully "responding" to gold that May.

In other words, while we probably should not expect the equities of mining companies to be as strong following the worst stock market panic since the Great Depression, we sure shouldn't start the very bad habit of making excuses for the indicators we rely on for guidance. Of course the massive new sales of equity by the miners (think Barrick) contribute to the underperformance, but probably not enough to cancel the overall effect.

For some perspective in the Gold Futures market, meanwhile, Comex commercial traders are now net short contracts representing 30.6 million ounces of gold metal – about 952 tonnes of paper gold bets that would improve if gold falls in price.

That gives new meaning to the phrase "motivated seller" doesn't it?

The chart above looks at just the nominal amount of commercial net short positioning. The chart below compares the Comex commercial net short position for gold with the total open interest (LCNS:TO). That gives us a better idea of how the largest hedgers and short sellers are positioned relative to the rest of the Comex traders.

As measured against all Comex open contracts, the relative commercial net short position snapped back up from 52.8% to 58.7% of all contracts open on the COMEX, division of NYMEX in New York. That's a large enough jump to be considered a warning-shot and we are back to an extremely high level, suggesting that commercial traders are once again confident or "determined" that gold will move lower near term.

We hasten to add, however, that the commercial "industry insiders" are not always right. The most recent example came on September 22 (a little over a month ago) as the LCNS:TO reached an all time record 61.8% of all the contracts open on the Comex. That was with gold at $1,014.96.

Gold has since broken above $1200 the ounce.

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