Good Morning,

Following yesterday's selling wave that brought values down to very near $920 an ounce, gold prices recovered slightly during the overnight hours. Mild bargain-hunting was seen in Asian markets and the precious metal was seen as benefiting from a small loss in the dollar (at 80.05 on the index) and a better than $1 rise in crude oil (now at $71.05 per barrel) primarily due to an upcoming report due to show US inventories on a declining trend for the past month.

Otherwise, the markets were rather calm as the new quarter got underway, and only the US employment-related statistics were seen as making any ripples in the summer market doldrums. Expectations are that job-cut projections in the US could come in at a 15-month low for the month that concluded yesterday.

Globally, a mixed bag of economic news remains the daily norm. China's manufacturing expanded for the fourth month in a row, as a result of its own stimulative actions over the past year. In Europe, the initial slowness to recognize the extent of the credit problem is creating a string of current problems. Thus, initials such as KBS,AIB, and others, are now making the rounds in the local headlines related to the crisis. In the UK, some 55,000 banking jobs are now being wiped off the slate, in order to keep new owners (the government) happy.

Spot gold prices started the midweek session with an $8.40 gain, quoted at $935.00 per ounce. The gain was still largely seen as an oil-led bounce ( we say, quite a bounce - almost enough to undo the damage in full) from the sell-off that took place on Tuesday, and the recapture of the $940-plus area is deemed as essential before significant progress can be made to higher ground. Support is thought to extend from the $912/15 area to current levels near $930. The market go a shot in the arm after the dollar lost sizeable ground on the heels of this morning's ADP report.

Marketwatch indicates that: The U.S. dollar declined versus major counterparts Wednesday after ADP Employment Services said private companies cut 473,000 jobs in June. The dollar, a measure of the greenback against a trade-weighted basket of currencies, traded at 79.905, down from 80.179 in North American trading late Monday. Economists surveyed by MarketWatch expected a decline of 498,000 jobs. Still to come, a report on manufacturing is expected to show improvement in that sector's outlook.

Traders may be reluctant to take on any fresh and/or sizeable positions ahead of Friday's holiday closure in the markets, but news of major significance such as the jobs figure, will force quick adjustments in thinking, if it hits between now and tomorrow's close. Silver added 12 cents too start at $13.67 per ounce, while the noble metals showed a bit of a mixed picture at the open. Platinum rose $9 to $1184 and palladium dropped $1 to $248 per ounce. The only bit of automotive news seen today, was an estimate that GM's unwinding might add up to 1.25 billion dollars. Expensive funeral, that.

Something else that deserves a decent burial is the (still) on-going gold/silver market manipulation talk. One of our readers from Down Under kindly pointed us to an article on GreenFaucet.com - whose lead mantra reads markets...demystified written by Brad Zigler at HardAssetInvestor.com just yesterday. Here is the essence of what Mr. Zigler conveys:

Central banks have, indeed, leased gold in the past, and they're likely to continue leasing as a tool to manage their currencies. That, like it or not, is a central bank's mandate: to deploy its reserves - of foreign exchange and metal - to tweak and fiddle with the value of the legal tender.

U.S. banks do, in fact, account for a substantial portion of COMEX open interest. That interest, too, has been pretty much entirely skewed to the short side since the Commodity Futures Trading Commission (CFTC) started reporting banks' market participation two years ago.

But is the existence of a large short position prima facie evidence of a manipulation? 
For a prosecution of manipulation under the Commodity Exchange Act to succeed, monopoly or domination of the market on the part of the alleged manipulators must be proven. In addition, it must be demonstrated that the perpetrators' manipulative acts resulted in the creation of an artificial price.

Put simply, making a futures manipulation charge stick boils down to answering two questions: Would the current gold price be different if the alleged manipulation hadn't occurred? More importantly, do the banks have the actual ability to influence the price of metal?

As a percentage of total open interest, U.S. banks' short interest has grown nearly 23% since June 2007. Over that same time, the COMEX spot price has risen almost 47%.
 

Table 1: Bank Participation in COMEX Gold Futures 
(05-Jun-07 to 02-Jun-09)

Mean
Reporting 
Banks

Median
Long
Interest

Median
Short
Interest

Short Interest
Correlation to
COMEX Price

Lagged 
Short Interest
Correlation to
COMEX Price

4

0.8%

13.7%

0.9%

14.0%

If banks were attempting to manipulate the price of metal downward over the past two years, they appear to have been singularly unsuccessful. Short interest in gold futures has ranged between 1.8% of the total market (July 2008) to 31.9% (June 2009). In that time, there has been no effective correlation (<1%) between the COMEX spot price and the size of banks' short interests. To prove the theory, we'd need to see a negative correlation. That would indicate that larger short interests coincide with lower metal prices.

Lagging the interest a month behind the price - in essence, allowing the short interest a month to impact the market - actually nudges the correlation in a positive direction. In other words, a build in the banks' short interest marginally correlates with increases in the price of gold.

There's really no conclusion to make here other than that banks' short futures exert little, if any, effect upon gold's cash price. If futures were being manipulated downward, COMEX prices should trade significantly under the London cash price. The standardized basis between the London A.M. fix and the COMEX spot settlement price has averaged just 2 basis points (0.02%) over the past year. Excursions outside one standard deviation (±1.8%) are mostly attributable to market volatility in the 8½-hour gap between the London fix and COMEX settlement. Of particular interest is the recent contraction in the variance, i.e., standard deviation halved to 0.9%, at the same time banks' short bias increased (see Figure 3).

Much has been made of the supposed concentration in the U.S. banks' precious metals futures positions. Observers have noted that a bare handful of financial institutions hold a significant portion of market open interest. Because of the lopsided way in which short interest has outweighed the banks' long positions, these observers have posited manipulative intent.

Table 2: Bank Short/Long Ratio in COMEX Gold Futures 
(05-Jun-07 to 02-Jun-09)

Median
Short/Long 
Ratio

High
Short/Long
Ratio

Low
Short/Long
Ratio

18.4

338.8

0.6

However, the correlation between gold futures prices and banks' short/long ratios appears to be no different than their price-to-short interest coefficient. Price depression isn't coincidental with spikes in the banks' short/long ratio.

Some claim that short positions as large as those of U.S. banks in the gold market are unprecedented. Not so. The short interest in Australian dollar futures held by non-U.S. banks have, over the past two years, been twice as large as the gold positions held by American institutions.

Table 3: Bank Participation in CME Australian Dollar Futures 
(05-Jun-07 to 02-Jun-09)

Mean
Reporting 
Banks

Median
Long
Interest

Median
Short
Interest

Short Interest
Correlation to
Interbank Cross

Lagged 
Short Interest
Correlation to
Interbank Cross

4

1.3%

28.1%

24.0%

18.6%

If a speculative intent for the banks' short Aussie dollar positions was imputed, it would appear these institutions were more successful in suppressing the currency's value than U.S. banks were in keeping gold's price in check.
Aussie short/long ratios have exhibited much greater variance than those seen in the gold market. Most notably, the high ratio for the dollar was eight times the size of gold's high ratio. Bank short/long ratios in the currency have registered over 100-to-1 for a third of the two-year CFTC reporting horizon. Gold short/long ratios, in contrast, topped the century mark only once.

Table 4: Bank Short/Long Ratio in CME Australian Dollar Futures 
(05-Jun-07 to 02-Jun-09)

Median
Short/Long 
Ratio

High
Short/Long
Ratio

Low
Short/Long
Ratio

14.8

2,835.9

0.0

Advocates of the manipulation argument assert that banks are engaging in an inherently speculative venture. Since large short interests in gold futures seem to have little effect upon metal prices, though, one naturally has to wonder why these for-profit enterprises would engage in these transactions. After all, bank management must answer to shareholders and directors. Unproductive or, worse, unprofitable, lines of business would likely raise eyebrows in the boardroom.

No tenable scenario has been offered to explain how these institutions would actually profit from the supposed suppression of gold prices. The banks' relationship to the Federal Reserve is often posited as evidence of a collusion of some sort, but the mechanics remained unspecified.

Commercial banks do, indeed, aid the Federal Reserve in the execution of monetary policy. That is, in fact, exactly what primary dealers - money center banks that bid at each auction of Treasury paper - do. Knowing that these dealers will provide a minimum bid for each offering of bills, notes and bonds allows the government to reliably refund at least a portion of its debt, and gives the primary banks an opportunity to obtain inventory that can be subsequently marketed to secondary financial institutions.

The bottom line is that the 16 or so banks and brokers that make up the primary market - including the dealing desks of the big gold derivatives players, HSBC Bank USA and JPMorgan Chase - undertake risk in exchange for a profit opportunity by acting as a wholesaler of government paper. There's no clear business model put forth by advocates of the manipulation argument for banks' short gold futures dealings.

Of course, there is another plausible argument - hedging.

The speculative position limit for COMEX gold futures is 6,000 contracts. The latest CFTC report shows three U.S. banks holding an aggregated net short position in excess of 123,000 contracts. If the banks were trading a proprietary speculative strategy, they'd be collectively limited to an 18,000-contract net position. Exemptions to position limits, however, are granted for bona fide hedge transactions - that is, positions that reduce a commercial enterprise's risk arising from changes in the value of its assets or liabilities. A short futures hedge would mitigate the risk engendered by a bank's undertaking of long metals exposure through physicals, forwards and swap agreements transacted with customers. Hedging would allow the banks to become more or less indifferent to the metal's market price.

At the very least, then, 105,000 contracts, or 85% of the banks' net gold futures positioning is the likely consequence of customer business flows rather than proprietary or manipulative interests. A look at the financial institutions' call reports will confirm the size of the over-the counter gold derivatives on their books. The hedge exemption would also explain the apparent difference in the regulatory attitude toward bank futures dealings and those of the Hunt brothers in the 1979-1980 silver market. 

The essential difference, of course, is intent. The Hunts attempted to corner the market by amassing long positions in physical silver and silver futures. The Hunts were engaged in a purely speculative venture; on one side of the market. There was no legitimate business risk offset by their long futures positions, and therefore no hedge exemption was warranted. It's unlikely that the points raised here will quiet the manipulation argument. These things tend to have lives of their own.

Remember, though, that this, like the previously published article, is a challenge to the assertion of criminal activity in the futures market alleged against U.S. banks and not an apologia for the government's monetary policy. What we can say is that, so far, there's been no evidence put forth to indicate that banks' futures market trading has risen to the level of criminal activity.

For our part, we have stated that there is no purpose in trying to manipulate something that is owned in larger amounts by individuals than by central banks. That something is gold. There would have been no $500 gold price, let alone $1000 gold, if the sinister forces were adequately doing their job. There would have been spectacular failures of the sinister shorts, way before the word 'subprime' was created. As for concentration of positions, sure they are concentrated. Why? Because we have literally shrunk down to one single (or less) handful of firms willing and able to make a market anymore.

Will any the above convince those who still continue to see gold's inability to get to the stratosphere as a clear sign that something must be very wrong? Surely, it will not. A religion is a religion, to be sure. After all, it was not that long ago that we posted a great article from WIRED magazine which delved into why it is that we all need a good conspiracy theory around and/or some very dark sheep to point our collective fingers at. Hey, it makes life more...interesting. So long as one does not throw good money out to read science fiction. For that, the fantasy section isles at Borders will do a whole lot better.

It is time for market projections, once again. Short and sweet. And, bear in mind, numbers are just that - a tool for traders. Our three-decade old motto has been IF you buy for the RIGHT reasons, you can IGNORE the price.

Gold - we raise our estimated price trading range by $50 on each end, for the next six months. $730 to $1030 with the same allowance we gave back at the end of December, for a $100 under/over shoot if spectacular conditions arise (examples: mass asset liquidation / Kim Jong Il losing it completely). There remains the chance of one more run/attempt to four-digits, but judging by the number of media mentions and general investor sentiment, the market is possibly heading for calmer waters, at somewhat lower levels than the $945 average seen in June.

Silver - Once again, a likely to be wide range and offering plenty of volatility and/or opportunity to make a buck. From $10.50 to $16.50 per ounce. Global economic conditions will continue to impact the white metal first and foremost. As we do not see those improving for nearly one year out, the progress towards anything like $20 will be quite a task.

Platinum - Ranging from $950 to just above $1250 per ounce. Keep checking the pulse of the auto sector, please.

Palladium - Ranging from $190 to just above $295 per ounce. As above. We still like the metal as a possible substitute for 'expensive' gold (jewelry) and platinum (autocats).

Rhodium - What??  You did not actually expect an actual number now, did you? How about a guess? Okay, from $990 to $2900 per ounce.

Happy Trading.