April 23, 2006 – A series of disparate events have coalesced that
have set the stage for generational price spikes in not one, not two, but in
three major metals. For those who have steadfastly held their gold and
silver positions through the difficult, trying and heart-wrenching past five
plus years, it appears that our foresight and suffering will soon be
rewarded. Similarly, for those who early recognized the explosive potential
of the copper market, they too are participants in what I believe will be
viewed as an historic short squeeze.
For
new investors to the stock and commodity markets, a speculator who believes
that an item will go down in price has the ability to sell it without owning
it. This is called shorting a market. If he is correct he will profit by the
difference between where he initiated his “short”, and the price
when he “covered” or closed out his position. A short squeeze
begins when a number of individuals or entities have “shorted” a
market in a substantial fashion, and find themselves on the wrong side of the
trade. In their haste to purchase the item and exit their trades, they
literally fall over one another and markedly drive higher its price.
A
good example occurred in the silver market between late1979 and early 1980.
Prior to the summer of 1979, Bunker and Herbert Hunt of the Hunt oil family,
accumulated an enormous silver position. As I recall, it was largely
completed by the summer of 1979, when silver was under about $8 an ounce.
Prior to and during this period many commercial
interests, traders, and speculators shorted a huge number of silver future
contracts as it rose in price. They believed there was sufficient readily
available physical silver to offset their positions. If they were correct
they would pocket the difference when the market declined under the pressure
of their massive shorting efforts, as it had done so many times before.
Unfortunately for the shorts, this time they were dead wrong.
By
September, 1979, silver broke above $10. This attracted world-wide buying of the
white metal by investors and speculators who had been watching from the
sidelines. They had seen silver languish, but grudgingly trend higher for a
number of years.
The
metal traded below $1.50 an ounce early in the decade. By the mid-1970's, it
worked its way into the $5 range. When it finally broke through $10, few
interested onlookers wanted to continue “to miss the boat”.
Investor after speculator then plunged into the market in order to secure
their silver.
This
pressured the shorts! With each up-tick in the metal’s price their
positions went deeper into the red. Finally, by December, 1979, silver
surpassed $20. When this occurred the shorts who had
not yet exited the market began to panic. They had already scoured the globe
attempting to find adequate silver stockpiles to cover their positions.
However, the Hunt brothers had beaten them to the act. The Hunts had left few
stones unturned in their effort to purchase all of the world’s
available silver. They had “cornered the market”.
This
placed the shorts in an untenable position. They had already sustained
enormous losses, and were now faced with bankruptcy if the white metal
continued higher in price.
By
now the shorts had joined the excited, greed-driven buyers of the metal. The
purchasers were fearful of missing further profits, and the remaining short
players were trying to fend off their financial Armageddon. By early
February, 1980, only a few brief months later, silver peaked at $52.50 an
ounce on the New York Commodity Exchange. When that price was struck the only
direction for the market was down. By this time numerous shorts were
devastated.
Some
background. In the early 1960's, the United States government
possessed a silver stockpile of about 2 billion ounces. During the latter
part of that decade our leaders decided that it no longer needed such a
substantial amount of silver, and began to sell most of it into the market.
Their weekly sales ended early in the 1970's decade, and only left our
country with a limited strategic stockpile earmarked for our national
security.
Beginning
in the mid-late 1980's and running to date, the world incurred an annual
silver supply deficit. Yearly demand exceeded production and silver recovery
from all sources by 50 to150 million ounces. The difference was made up from
above ground known and secreted sources.
Several
years ago it became obvious to me that at some point the world would run out
of sufficient silver to supply its needs. I stated my belief that when that
time arrived silver would skyrocket in price. I
believe that we have now arrived at the demarcation point where all of the
readily available silver has been all but consumed.
Of
possibly greater importance is that the future of silver’s price will
be further impacted by another factor. That is the enormous short position
that is currently in place.
For
the past few decades it has been a safe bet for various commercial interests,
bullion banks and others to short silver whenever it ran up in price. They
understood silver like few others because most of them were major daily
players in the white metal’s market. This group repeatedly profited on
the short side because from experience, they knew that they would eventually
be able to access sufficient silver supplies to offset their sales.
To
their detriment this group was apparently lulled into complacency due to
their earlier successes in acquiring silver in a timely fashion. They ignored
the fundamental ongoing supply deficit that would one day upend their
lucrative trade. I have read statements that there is a
overhanging world short position in excess of 1 billion ounces of silver.
Where will it come from when the shorts need it?
Turning
to gold, the yellow metal has been in an annual supply shortfall for about 15
years. It is presently running at about 1,000 tonnes annually. Further, it
has been stated by Frank Venerosa and the Gold
Anti-Trust Action Committee (GATA) that the world’s major governments
have loaned out as much as half of their stated 30 thousand tonne gold hoard.
This gold has been sold into the market but must one day be repaid to their
rightful government owners. Additionally, there are additional millions of
ounces of the yellow metal that has been shorted on the commodity exchanges,
or are otherwise owed via naked call options or other derivative methods.
These are on the books of various bullion banks, gold mining companies and
other entities who underestimated the great groundswell of demand that would
one day target the eternal metal.
To
further confirm the underpinning of gold’s strength is its recent price
action. As I discussed when gold first attacked the $500 mark, it should have
been met with great overhead resistance! However, the fact that it overcame
that level and continued skyward with nary a pause,
indicates the great global thirst for the metal.
Each
price reversal was met with enormous buying. It appears that numerous
substantial entities have given up accumulating the yellow metal in an
orderly fashion. They now seem to have thrown in the towel and are rushing to
purchase whatever quantities they can on any price dip. If this is the
correct analysis, it is the reason why any price weakness will likely be
muted in time and depth as gold trends higher in its current upwave.
Finally
we have copper. In my November, 2005 issue of Financial Insights I discussed
copper in depth. I mentioned the usual obvious reason for its great global
demand; the insatiable demand from China, India, Brazil, the United States
etc., its supply vs. demand shortfall, as well as the continuing decline in
its above ground stocks. These seemed likely to be the underlying factors
supporting its theretofore meteoric rise, and suggested to me even loftier
future prices.
However,
what peaked my interest and compelled me to discuss
this metal was the actual decline in the net commercial short position.
Copper had risen from the low $0.60 range in late 2001, to its then price in
the mid-$1.80's. Yet with copper posting new all-time highs, the shorts were
nowhere to be seen. It was as if they were afraid to bet against its advance.
The
situation clarified a few weeks later. A rumor
surfaced that China’s
major copper trader was short between 100,000 and 200,000 tonnes of the
metal. I stated in my December, 2005 newsletter that, “It remains to be
seen what the outcome will be. However, I believe that it is likely that
there is a massive short position overhanging the market,
that has the potential to drive it significantly higher”.
With
gold and silver, their fifteen year to two decade long supply deficits have created an extremely tight market. Copper’s
supply deficit has only existed since 2003. However, the overwhelming copper
demand appears to have quickly consumed literally all of the above ground
stockpiles.
This
does not even take into account the amount of physical gold that is being
taken from the market by the gold exchange traded funds (ETFs),
and that will be purchased by the first approaching silver ETF and future
ones. Further, the potential explosive price advances, that
the supply deficits for each of these metals has the ability to engender, may
be greatly extended if the great short positions unwind in one or all of
their markets.
Another
item that will further propel these markets higher is the recent action of
the U.S. dollar. As depicted by the U.S. Dollar Index, it appears to be on
the verge of finally breaking down! This indicates the potential for new
lows. If this index breaks its earlier support of just over 0.80, be prepared
for a new burst of strength in all of these metals. It will raise the yen,
euro, pound, yuan and all other currency prices of
these metals, and further attract speculators from all nations into the fray.
Additionally, it will signal potential domestic inflation and a flight from
the dollar.
The
final piece to the puzzle appears to have fallen into place. It is the action
of the open interest on the commodity exchanges for each of these markets.
The open interest indicates the number of outstanding contracts for a given
commodity. During important bull advances the open interest tends to expand
as an increasing number of investors and speculators enter the market.
However, in the recent cases for gold, silver and copper, they have contracted.
Gold’s
open interest on the New York Commodity Exchange (Comex)
peaked when it was trading at about $475. Silver’s struck its highest
level when the white metal traded at about $8. For copper, it’s
open interest posted its high when the red metal touched $1.50.
Gold,
silver and copper are now trading at over 33%, 50% and 100% respectively,
above the points where they posted their peak open interest levels. This can
likely only indicate one thing! And, that is the trapped short-sellers are
running for cover, and are exiting the market.
When
an earlier short seller makes a purchase to close his position, he must be
replaced by a new seller. This is because every commodity market contract
must have a buyer for every seller. The reason why the open interests in
these metals are not expanding is because the short players are closing their
positions as fast, if not faster, than new traders can enter the market. Had
the short sellers not been covering their earlier sales, the new buyers would
create an increase in the total open interest.
If
my analysis is correct the fireworks have just begun. We will likely continue
to experience violent price movements in all of these metals as we
experienced late last week. As waves of short-covering end, new short sellers
will pound the markets. Conversely, when one or more major shorts panic in
their effort to limit their already enormous losses, these metals will soar.
Gold
suffered a major $20 plus decline and silver gave up over $2 last Thursday.
These serious price reversals should normally require a few or more weeks for
the metals to recover and overcome the technical damage done to their
markets. If they shortly post new highs it will confirm that a short squeeze
is indeed likely in progress.
It
is impossible to predict the timing or the heights to which gold, silver or
copper will spiral before the final shorts cover their positions. However,
beware of a rule change on the Comex. In early
1980, the board of governors of the Comex changed
the rules for silver when it was exploding higher. They announced that only
liquidation orders would be accepted. With that edict silver plummeted limit
down for nearly two weeks and trapped the longs. Numerous long players with
substantial paper profits were decimated while many short-sellers were spared
from annihilation.
Finally,
I anticipate when gold, silver and copper post their highs the stage will be
set for a prolonged secondary correction in each of their markets. If we have
a repeat of the1970's price action, we will have to endure an extended
decline that may see these markets lose 50% of their peak values. However, do
not despair. When the lows arrive they will present those who sold within 20%
of the market peaks with great profits. These can be utilized to reposition
oneself and profit, when these three major secular Bull Markets again
reassert themselves. This, on their way to their ultimate, higher peaks a few
or more years later.
______________________________
The above was excerpted from the
May 2006 issue of Financial Insights © April 23, 2006.
By
: Dr. Richard
S. Appel
www.financialinsights.org
I publish Financial
Insights. It is a monthly newsletter in which I discuss gold, the financial
markets, as well as various junior resource stocks that I believe offer great
price appreciation potential.
Please
visit my website www.financialinsights.org where
you will be able to view previous issues of Financial Insights, as well as
the companies that I am presently following. You will also be able to learn
about me and about a special subscription offer.
CAVEAT
I
expect to have positions in many of the stocks that I discuss in these
letters, and I will always disclose them to you. In essence, I will be
putting my money where my mouth is! However, if this troubles you please
avoid those that I own! I will attempt wherever possible, to offer stocks
that I believe will allow my subscribers to participate without unduly
affecting the stock price. It is my desire for my subscribers to purchase
their stock as cheaply as possible. I would also suggest to beginning
purchasers of these stocks, the following:
always place limit orders when making purchases. If you don't, you run the
risk of paying too much because you may inadvertently and unnecessarily raise
the price. It may take a little patience, but in the long run you will save
yourself a significant sum of money. In order to have a chance for success in
this market, you must spread your risk among several companies. To that end,
you should divide your available risk money into equal increments. These are
all speculations! Never invest any money in these stocks that you could not
afford to lose all of
Please call the companies regularly. They are controlling
your investments.
FINANCIAL INSIGHTS is written and published by Dr. Richard Appel
and is made available for informational purposes only. Dr. Appel pledges to disclose if he directly or indirectly
has a position in any of the securities mentioned. He will make every effort
to obtain information from sources believed to be reliable, but its accuracy
and completeness cannot be guaranteed. Dr. Appel
encourages your letters and emails, but cannot respond personally. Be assured
that all letters will be read and considered for response in future letters.
It is in your best interest to contact any company in which you consider
investing, regarding their financial statements and corporate information.
Further, you should thoroughly research and consult with a professional
investment advisor before making any equity investments. Use of any
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