Major
Banks Buy Gold and Silver By Patrick A. Heller,
Market Update
May 04, 2009
Three
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 the price.
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 supply shortage.
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
metals.
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.