Banks Buy Gold and Silver By Patrick A. Heller,
May 04, 2009
times since late 2005, commodity analyst Adrian Douglas predicted
major rises in the price of gold. In November 2005, when gold
was about $450, he forecast gold reaching $720 after noticing
a large increase in the number of call options in shares of
gold mining companies. In August 2007, when gold was $660,
he noticed a significant increase in call options for the
COMEX December 2007 gold contracts, where gold surpassed $1,000
seven months later.
In July 2008, Douglas noted a huge build-up of COMEX December
2008 call options. Shortly after his prediction of higher
gold prices by year end, two large banks (probably JPMorgan
Chase and HSBC) sold short gold futures equal to 10 percent
of annual worldwide gold production. Douglas's prediction
of a major rise in the price of gold by the end of December
2008 did not occur, but he still expects a major blow up of
Douglas's research has been highly reliable and his predictions
have a better track record than most forecasters. When he
has something to say, I listen.
Last week, Douglas reported receiving information from two
confidential sources that JPMorgan Chase and Goldman Sachs
had been buying large amounts of COMEX gold and silver call
options in both the June 2009 and December 2009 contracts.
His analysis of the COMEX June 2009 gold option contracts
shows that calls (which are contracts where the owner has
the option to demand delivery at the contract price prior
to the expiration date) outnumber puts (where the owner has
the option to demand that the seller of the contract buy at
the contract price up to the expiration date) by more than
80 percent. In addition to being overly skewed toward call
contracts, there is an exceptionally large quantity of contracts.
The COMEX December 2009 gold option call contracts outnumber
puts by 130 percent.
In the silver market, the COMEX June 2009 call options exceed
puts by 80 percent. December 2009 call options exceed puts
by 68 percent.
Activity in options for both metals is especially concentrated
in the June and December contracts.
Douglas considers options traders generally to be highly
sophisticated speculators. They can purchase large quantities
of contracts at very low prices if the strike prices are considered
to be "out of the money" (that is, it is so far
from current spot prices that the seller of the contract thinks
there is little likelihood that the contract will be executed).
Such traders make a profit if they acquire their options ahead
of the major price moves in the futures markets.
Douglas interprets this data to mean that smart money is
being positioned in anticipation of a massive rise in the
price of gold within 30 days and in silver's price within
the next 60 days. Then he looks for another jump in prices
by December. There could be a price pullback in between the
two major rises.
Douglas included two other bits of data as part of this analysis.
First he notes that the call/put ratio in the stock market
is usually a contrary indicator because such options are mostly
purchased by unsophisticated retail investors who often get
it wrong. In contrast, the bulk of activity in precious metals
options tends to be from sophisticated investors. Second,
both the gold and silver futures markets are now bordering
on backwardation, which signals a near-term major physical
There were several developments last week that added more
bad news for the economy, the value of the U.S. dollar, and
the credibility of the U.S. government. To save space, I will
omit discussion of the Chrysler bankruptcy and the developing
fiasco of the "stress tests" of U.S. banks.
Warren Buffet, CEO of Berkshire Hathaway and one of the world's
richest investors, told the company's 35,000 shareholders
over the weekend that they should expect higher inflation
and a significant decline in the value of the U.S. dollar.
Buffet is not a gold bug by any means, but, to unsophisticated
investors, his forecast makes a strong case for owning precious
Two weeks ago, Neil Barofsky, the special inspector general
overseeing the Troubled Asset Relief Program (the TARP bailout
enacted last September) released a 250-page report detailing
problems with the way that funds have been disbursed. Depending
on which report you see, there are between 20 and 40 investigations
under way that may result in criminal charges. He is concerned
that the structure of the TARP bailout makes it too easy for
frauds, scams, collusions, conflicts of interest, and illegal
money laundering. A particular focus of his investigations
is what happened to the funds given to AIG as a conduit to
other financial institutions such as Goldman Sachs.
Last week, the interest rate on 10-year U.S. Treasury debt
rose above 3 percent. Foreign buyers have cut way back on
their purchases of long-term U.S. Treasury debt, with the
result that the Federal Reserve is becoming the major buyer
of such bonds. The rise in interest rates signifies a long-term
expectation of a decline in the value of the U.S. dollar.
Physical metals supply update:
In the past several days there have been widespread declines
in premium levels of physical gold and silver products. In
some instances, such as U.S. one-ounce Gold American Eagles,
premium levels are nearly back to typical long-term levels,
with supplies available for 1-2 weeks delivery. The price
of U.S. 90 percent silver coins has fallen about 7 percent
in the past 10 days even though the spot price is still about
the same. Premiums on silver Eagles are also down about $1.50
in the past 10 days.
At the Central States Numismatic Society show in Cincinnati
last weekend, there were several dealers who had quantities
of fractional gold Eagles on display, offered at premiums
much lower than recent history. There is an expectation that
the U.S. Mint has almost caught up to demand for one-ounce
gold Eagles, which could soon make it possible to begin making
fractional gold Eagles and maybe even gold Buffaloes, all
of which have not been struck for more than six months.
Typically, when premiums are falling, that is a sign there
is a surplus of supply. I don't think that is an accurate
assessment of the current physical gold and silver market.
What we are seeing is a return to close to normal premiums
of the past, not a decline below those levels. Also, when
premium levels shot way up and delivery times dragged out,
a number of potential buyers opted not to purchase at all
(in my company's retail showroom, there are multiple customers
every week who would only purchase what they could immediately
take with them). Finally, as premiums rose, there was some
shift to larger ingots (kilogram and 100-ounce gold bars and
1,000-ounce silver bars) to take advantage of the relatively
lower cost per ounce.
As the average American interested in owning physical gold
and silver learns that product is available and can be bought
at reasonable premiums, I expect demand to increase.