Market Report: Hey ho, and up she rises….

Feb 17, 2017·Alasdair Macleod

The Trump administration is running into choppy waters, commodity prices are on the up, and inflation is around the corner.

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After a slow start, gold and silver resumed their uptrends this week, with both metals edging into new high ground. Gold rose slightly from $1233.5 at last Friday’s close to $1237, and silver from $17.95 to $18.03 in early European trade this morning. It has been the pattern for the last month that instead of drifting lower over the course of Fridays, precious metal prices have rallied in US trading hours, so this week’s uptrend may have further to go before the week is out.

The performance of both metals has a good feel about it. From the pre-Christmas lows, gold is now up 10% and silver by 14.8% so far. Physical demand continues to feed ETFs, and gold’s open interest on Comex is noticeably lagging the price. This is illustrated in the next chart.

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While there has been a small pick-up in open interest, the gap opened by the price is remarkable (arrowed). This tells us that futures buying, as opposed to bear closing, has yet to occur, and the hedge funds are missing the boat, presumably still being long of the dollar. Silver is a different story. Here, open interest has marched in step with the price, as shown in the next chart.

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Open interest in silver has risen to nearly 200,000 contracts, representing one billion ounces, against annual production of about 890 million ounces. Who has the positions? In this case, it is the managed money category. The difference with gold is that gold is counterpart to the dollar, so you short one to go long the other. This is not the case with silver, which is rising with the other metals.

Metals generally are strong, because China’s economy is strong. Chinese demand for electricity infrastructure and general manufacturing purposes is driving copper higher. And where Dr Copper goes, the others follow.

There is increasing evidence that financial markets have misread China. Any objective analyst should understand China’s economic strategy. The build-up of the Silk Road projects, the filling out of China’s own infrastructure shortcomings, the deliberate creation of the largest middle class in the world adding another 200 million urbanites within a few years, and the increasing emphasis on services and technology; all these are being implemented with the broad support of the Chinese people.

This mood is catching. China’s supply chains embrace Japan and South East Asia. Even in Europe, things are picking up round a core comprised of Germany, the Czech Republic and Austria. Economic surprises, and therefore inflation, are to the upside. Industrial demand for silver is therefore growing, while supply is inflexible.

This is reflected in the gold/silver ratio, the subject of our last chart.

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The downtrend is well-established, and anyone looking at this chart would at the margin probably buy silver rather than gold.

Gold, as always, is Tweedledum to the dollar’s Tweedledee. Having been very strong in the wake of the presidential election, the bear arguments against the dollar are mounting. The Trump administration is running into choppy waters, commodity prices are on the up, and inflation is around the corner. Add to this the Asian desire, driven admittedly by China’s insistence on non-dollar contracts, to reduce the dollar component of foreign reserves, and suddenly the dollar has some downside, while gold looks mispriced.

No wonder Friday has been seeing higher gold prices. The risk ahead of weekends is being long dollar/short gold, not the other way around. However, it is option expiry on Comex next week, so expect the unexpected.