The melt-up in precious metals (with the exception of platinum) resumed with the start of the new trading week, reflecting the the crude oil-fueled commodities rally that has gripped the world's trading floors since the start of the Libyan upheaval. Recent clashes in that country have turned even bloodier as Mr. Gaddafi's forces intensified their campaign to recapture a couple of key cities along the coast. Black gold has already leapt 25% since Libya descended into the state of civil war it is now in.

Outside military intervention showed no signs of materializing, and was still under consideration, lacking sufficient consensus by global powers. This, even as the humanitarian crisis was aggravating with each passing hour, having already resulted in the exodus of more than 150,000 people to Tunisia and to Egypt. Meanwhile, some protests continued in Yemen and Bahrain, but Saudi Arabia remained relatively calm. The fear premium being reflected in nearly $107-per-barrel crude oil continued to spill over to other commodities and it remains the main source of momentum behind the fresh records being set in gold and silver prices.

The Libyan situation has prompted the Obama administration to consider resorting to the US' Strategic Petroleum Reserve in an effort to curb the potential economic reverberations that the resultant spike in energy values is engendering. The emergent US economic recovery stands a realistic chance of being derailed if $100-$115 oil remains on the price boards for an extended period of time, or if $140+ crude were to rematerialize, complete with $5 per gallon gasoline, just as spring and summer roll around. The latest, 2.35% advance in WTI crude (to $106.55) and the 2.2% rise in Brent crude (to $118.50 pbbl) have ignited fears that consumers will stop consuming and that employers will halt employing folks.

Precious metals trading got off to a flying start on Monday, with gold prices rallying by $11.10 per troy ounce, and they were initially quoted at $1,443.90 on the bid side of spot after having touched early highs at a new, $1,445.90 per ounce record. Gold trading positioning continued to show a rise in open interest for the latest reporting period (ending on March 4) and the net speculative length in the yellow metal is at its most robust thus far in 2011. Gold ETF balances however continued to experience some on-going leakage in their underlying tonnage, despite the recent, headline-making ascent in the metal's value.

Over at the PDAC event in Toronto (amply covered by Kitco News), the mood is quite upbeat; no surprise, following the performance that gold and silver turned in during 2010. However, at least one speaker on Sunday sounded a bit of a cautionary alarm when dissecting the picture in gold, as it relates to macro funds. Heavy courtship by hedge funds and similar spec players has propelled bullion values to stratospheric levels in each of the past two year, at least. However, the behavior of said players is precisely what was on the mind of JP Morgan strategist Michael Jansen as he addressed the crowd of diggers yesterday:

We are a little bit concerned about the signs of some fault lines emerging in the market. For one thing, there has been a shift by wholesale investors and some funds out of gold and back into equities, which now look quite cheap compared with the yellow metal. We have received a lot of feedback at the significant wholesale investor level, or the big macro funds, and they are generally starting to pull back their exposure to gold and get more exposure towards equities. We see equities emerging from a multi-year funk and moving into a two or three year bull market. And that obviously reduces the need for a portfolio hedge like gold.

Mr. Jansen also threw a bit of cold water on the assertions that we are in some kind of 'peak gold' condition, as his firm believes that mining output of bullion will increase by about 3 to 4 percent in 2011 and in coming years as well, continuing the pattern we have already revealed to you in these columns over the past three years. With margins such as the current ones being enjoyed by the majority of the PDAC's attendees, such a little fact should come as no surprise. Mr. Jansen also noted that the steepening Treasury yield-curve is prompting some gold market players to begin shifting out of the metal and into equities that now appear to be cheap.

Also from the stages of the PDAC, and focusing on the same idea of changing interest rate conditions, comes word that while the current low real interest rate conditions are still conducive to the types of gains we have recently witnessed in the metals' (and other commodities) complex, the changing trend in same could have some deleterious effects on prices.

GFMS Chairman Philip Klapwijk alluded to the fact that the froth we are experiencing in certain commodities, and precious metals in particular, could be taken out when more countries begin to hike rates as India and China already have. Thus, we advise, keep an eye on the ECB and the Fed for the latter part of this year, and in 2012.

Silver prices soared to a high of $36.79 per ounce, and then opened at $36.66 on the spot market with a gain of 99 cents. Whilst silver-oriented ETFs reported a robust inflow of ounces, the open interest in the white metal did show a decline on the aforementioned reporting period, and it was the first such shrinkage since near the end of January. Copper prices, also showing signs that they have vaulted way ahead of fundamentals-based levels, were indicating that heavy speculative trading is afoot on the COMEX.

Platinum and palladium opened on the mixed side this morning, with the former showing a $3 decline to $1,838.00 the ounce and the latter ticking higher by the same amount, to reach $813.00 per troy ounce. ETFs specializing in the noble metals showed increased in platinum balances but some outflows from palladium ones. Overall however, the PGM niche seems to indicate the same heavy-handed speculation that is currently defining oil, copper, and silver and it could result in sizeable price shifts should conditions around the world turn on the proverbial dime.

Such turns were already manifest later this morning, when oil halved its earlier gains, and gold prices fell into the red just one hour after having opened with the aforementioned robust gains. Volatility remains very much on the scene as spec funds exhibit intense activity and will not shy away from profit-taking at any moment. At last check, platinum was down $12, palladium fell $11, and silver was ahead by only 44 cents. Chalk it up to...oil. Oh, and the US dollar clawed its way back to 76.33 on the trade-weighted index.

Something else may have also contributed to the emergent profit-taking (aside from new records being etched into certain books) in metals this morning; the words of Dallas Fed President Richard Fisher. He said that under certain conditions he might vote to truncate the Fed's QE2 asset purchase program: I remain doubtful enough as to its efficacy that if at any time between now and June, it should prove demonstrably counterproductive, I will vote to curtail or perhaps discontinue it. Mr. Fisher repeated that he would vote against extending or enlarging the purchases barring some frightful development.

 

Well, Libya is a pretty frightful development at the moment, one would say (especially if they happen to be long oil or gold). However, the type of really frightful development that is on Premier Wen Jiabao's mind is more important in terms of needing to be paid attention to. We are talking about inflation and the risks it might pose along several fronts, not the least of which would be the social one.

The Chinese Premier, in his opening speech at the annual National People's Congress taking place in Beijing pledged to rein in spiking consumer and property prices, and he said that this anti-inflation fight is now the nation's top priority. China's leader is well aware that rising prices for everything might well mean rising tempers among the masses and a rising risk of such tempers flaring up into events similar to those now taking place in the MENA region.

Therefore, we read with no degree of surprise that Standard Bank's commodities analytical team writes this morning that given that Chinese consumer and inflation numbers are set to be released this Friday, we could see another round of monetary tightening in the next few days. Looking at the PBOC's actions in the past this will most likely come in the form of an increase in the reserve requirement. However, we have determined that raising reserve requirements are the bluntest in their effect on commodity prices. At worst, we would expect a knee-jerk sell off in reaction to news of an increase in the required deposit ratio.

 

Keeping an eye on all types of combat (in Libya, in the crude oil pits, by longs versus the shorts, by the bulls versus the bears, and the emergent anti-inflation battle by central bankers and national leaders) we remain at our post

Until tomorrow

Jon Nadler Senior Analyst 
Kitco Metals Inc. North America
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