Silver, the Fed, and the Election Cycle

[oroborean]

It's obvious that the silver market is being moved by forces outside the supply/demand fundamentals of the commodity. Whether it's manipulation or just the aggregate effect of movements by large market participants, the spot price of silver has shown some interesting fluctuation this past week, all of which must be viewed through the lens of the US Fed and central banks in general, and the November mid-term elections.

The first priority of Paulson and Bernanke FOMC is to make the GOP look credible, if not actually good, for November. Oil had to come down, and commodities with it. They had to explain the economic slowdown, so talk of the soft-landing scenario was born. They had to sound hawkish to keep the dollar propped up, so their minutes speak of inflation, not rate cuts. But, despite the relatively hawkish talk out of Philadelphia, bond markets are still pricing in a rate cut early next year, not a future hike. Expectation of an economic slowdown tends to move investment dollars away from commodities, even though demand for gold and silver is not likely to decrease much, if at all. It will probably be some time before investors realize this, but if we are at the end of rate hikes, or at least if that notion gains traction, then silver should benefit, as a downturn in the US and of the USD will only hasten the flight to alternative investments globally. The foreign markets, have loved silver all week on a value basis and seem to be taking advantage of vicious NY selling to hedge against what they view is the inevitable downturn of the dollar.

Today, mining stocks were not able to take advantage of overnight buying in silver because the market still incorrectly perceives that a slowdown or recession in the US will hurt silver prices. The fact that central banks are falling well below their gold sale quota indicates their belief that either the dollar will trend down and gold will trend up, or they are simply running out of supply with which to artificially depress spot prices -- both of which are incredibly bullish for metals!! The fact is that silver will continue to be subject to wild fluctuations at least through October, but probably through the New Year, after which the White House will once again ramp up it's Iran invasion rhetoric, oil will perk up again, the Fed will contemplate cutting, the dollar will drop, and silver will soar!!!

[oroborean]

Monday's trading offered some clarity on the previous post. New York traders again took down silver and commodities, until that is, the early afternoon rally. Having digested the weak existing home sales figures, the bond market renewed its inversion as traders priced in a rate cut in January. Of course, a rate cut will be bearish for the dollar and bullish for gold and silver!!

So, the question becomes -- will they do it? The market is playing a terrific game of chicken with the Fed. If the Fed doesn't cut by January, all the major indices are headed for a huge tumble. If the Fed capitulates and does cut, there is untold inflation fighting credibility to be lost as the dollar would likely scream toward a fresh low and commodities renew their bull market. Given that the trade deficit could be helped by a weak dollar, and that major accountability points -- holiday shopping and midterm elections -- will be passed, early 2007 seems to be an excellent time for Fed to reverse its position and try its hand at the dangerous game of rate cutting. If so, hold on to your physical silver and silver stocks!!

The one catch: between now and January oil is predicted to trade lower. So far this year, the metals have largely followed oil's lead. Today, the fresh liquidity perspective is winning and both oil and silver are moving higher. Will metals decouple from oil as traders pick up on the inflation hedge as opposed to the industrial demand driver for metals prices? Or will traders continue to incorrectly think that decreased demand for oil and increased supplies have anything to do with the increasingly favorable fundamentals for silver? The foreign markets don't seem to think so!! Comments?

[oroborean]

The short-lived rally in NY silver this week corresponded exactly with the spike in Fed rate-cut expectations after the Philadelphia bank released numbers that indicated the overall economy may be slowing more than previously expected. The promise of easier money boosted commodities across the board and helped bring the dow near record high levels. The weak economy scenario lost traction almost immediately, however, and the final nail was put its coffin today with the release of strong Chicago Fed manufacturing index numbers. As a result, rate-cuts odds continue to drop, easy money is no longer in sight, and markets and commodities sell off. This temporary setback notwithstanding, it is entirely possible that economic indicators change the big picture and market finds itself once again contemplating rate cuts in early 2007, or that geopolitical events force speculation in tangible assets. In the short term, however, prevailing market sentiments are a headwind against new buying in commodities. A perceived worsening of the US economy or decrease in inflation expectations would be bullish to the extent they increase the odds of a rate cut.

Additionally, the action in oil this week was not the indicator I'd hoped it would be. Oil traded up on low inventories, which is sound supply/demand economics and not illuminating of broader economic factors. Silver continues to trade with oil and commodities in general, but I continue to believe that a decoupling from oil will be a confirmation that supply/demand factors are exerting control of the silver market. As always, I welcome comments, public or private, on the views expressed in this and other threads on the Silverseek forum.

EDIT: UPDATE: The reversal today in oil is said to be short-covering as traders choose not to go into the holiday weekend short oil. Silver and gold likely traded in sympathy and may have received support by the expansion of SLV release. Given the seemingly conflicting Fed reports and up and down sentiment about the economy this week, the overall picture is not clear and today's moves are not a signal of the next trend. With Bernanke speaking next week and another important report on Monday, look for next week's action to determine economic outlook and silver's behavior into November.

[oroborean]

As mentioned in another thread, this feel-good equity fervor, fanned by the cheerleaders at CNBC, is driving the major indexes regardless of what news or data is released. As now mentioned in several external sources, but I believe first mentioned by me here in this thread, there is a strong correlation between market action over the past month and the political interests of the GOP. So, even though Bernanke mentioned factors that will the housing market to stabilize and referred to inflation as being above comfort levels, the market interprets his reference to a "significant correction" as a green light for rate-cuts. Once again, the news is simply spun to match the desired outcome.

So, I would like to say we got some bottoming action in oil and silver, but if today's upward movement is caused by a dubious expectation of a short term rate-cut, then, like the last recent rally, this one is likely to be short-lived. The pattern to this point is that some piece of data, like manufacturing growth, housing sales, or job creation, creates expectations of a hard-landing and thus a rate-cut -- all of which rallies the markets. Then, sense kicks in and the economy is seen as merely moderating and heading for a soft-landing, which good news causes the market to rally. Then, just as the momentum is sliding, some new evidence is found for a hard-landing and a rate-cut and so the cycle continues. Silver and commodities, however, only benefit from the rate-cut scenario, but are brought back in check by the soft-landing. The rate-cut scenario is inflationary and sensational, therefore much more risky and short-lived compared to the soft-landing periods. Hence the mostly sideways to down action in silver. That said, if the soft-landing scenario doesn't retake the dominant position soon and the short term rate-cut expectation persists, then this is very likely the start of the next wave up for commodities. Long term silver buyers should absolutely view this as a low-cost entry point, but near termers might rightly remain skeptical.

I'm more of an analyst than a prognosticator, but it's too tempting from time to time to extrapolate into the future. In this spirit, I'm revising my expectation for the commodity market to remain depressed through the holidays into the New Year to include the possibility that the bottom will occur prior to the holidays, but will be largely overlooked during the holiday season or attributed to lower volume trading. By that point, after all, the election will be history and rumbles in Korea, Iran, Africa and in the macro-economy will begin to loom larger. It would be a mistake, however, to underestimate the ability of the government-media complex to manufacture whatever short term market conditions they choose.

[oroborean]

The pattern to this point is that some piece of data, like manufacturing growth, housing sales, or job creation, creates expectations of a hard-landing and thus a rate-cut -- all of which rallies the markets. Then, sense kicks in and the economy is seen as merely moderating and heading for a soft-landing, which good news causes the market to rally. Then, just as the momentum is sliding, some new evidence is found for a hard-landing and a rate-cut and so the cycle continues. Silver and commodities, however, only benefit from the rate-cut scenario, but are brought back in check by the soft-landing. The rate-cut scenario is inflationary and sensational, therefore much more risky and short-lived compared to the soft-landing periods.

The above might best be titled "Recipe for a Goldilocks Economy". And so, as if according to recipe, comments by FOMC Vice-Chairman Donald Kohn last night and by Philadelphia Fed President Charles Plosser today are now on the record indicating that the infaltionary risk is too high, that the economy is set to actually strengthen in '07, and that there is by no means a sense among the Fed governors that a rate-cut is imminent. When the rate-cut idea was needed to drive markets higher, the market found it. Now the Fed has stepped in to quash this inflationary view and all that's needed to completely validate everything above is for the market to still rally on the completely opposite macro-ecomoic view. Even a few days of digestion and sideways trading before the next uptrend will satisfy the Goldilocks recipe. As I type this the Nasdaq is positive, but the Dow and S&P are fractionally down, but the trading day is only half over.


EDIT: UPDATE: At the close, all the major indexes were positive for the day. While the Goldilocks recipe is successfully turning out delicious new multi-year and all-time highs, it's notable that the undercurrent is beginning to shift away from the soft-landing scenario. Or so it seems. An interesting stat came out today that in the last week investors have been avoiding US-based stocks and putting their money in foreign companies and companies with overseas operations. This makes sense as expectations are for the Fed to pause or cut while foreign central banks are tightening their money supply. Foreign investment benefits from a weaker dollar and so do commodities priced in USD.

[oroborean]

It became vogue over the past week to discuss issues related to this thread, but unfortunately, for the masses, the conversation was limited to something like, Is George Bush lowering gasoline prices for political gain?, which is of course a gross over-simplification. As discussed in this thread, the Fed has been on at least a month-long campaign to kill commodities and create a strong bond market so as to paint a rosy scenario in the short term and justify eventual rate-cuts for continued "prosperity". Talking out of both sides of its mouth, about containing inflation in public while increasing credit and expanding the money supply, the Fed has sought to pull markets in both directions to create a sense of the fabled "just-right" Goldilocks economy. As expected, the market rallied when economic data pointed to a recession and rate-cuts and then rallied again when data instead pointed to a soft-landing and no rate-cuts!

Silver trading up today on decreased rate-cut expectations, however, proves dependence on the Goldilocks recipe is becoming overdone and that the white metal is, for now at least, breaking free from the U.S. market manipulators and trading on supply/demand fundamentals. Unfortunately, not it's own. OPEC production cuts have oil and alternative investments, the inflation hedges, moving up today, with silver moving in sympathy mostly to oil. While this is good news and may confirm the recent bottom, it is not the product of silver's bullish fundamentals, massive short-covering or strong silver speculation, and therefore not necessarily the start of the next leg up. I continue looking for silver to outperform oil and gold as clear sign of silver fundamentals asserting control in their market.

For rate-cut expectations to reignite, and with it the broad commodity bull, the major stock indices probably need to trim their recent gains, earnings need to slow and the overall market picture needs to deteriorate in the mainstream view. Of course, in the meantime, anything that helps oil without putting the brakes on global development is going to lift silver and gold, but anything that moderates or drops oil will also take down silver.

[oroborean]

Today's release of last month's Fed minutes was a reprise of its hawkish song on inflation. Of course, inflation, particularly in the form of high oil and gold (and silver) prices is the greatest obstacle to the bull's wildest dreams of rate-cuts, easy money and even newer, higher highs on the major indexes. Eventually, there's a strong likelihood the Fed will do an about-face and embrace the rate-cut scenario, but for the pre-election build it needs a strong economy and low commodity prices and will continue to sing this tune.

As discussed previously in this thread, every time negative data in the past two to three months have threatened the credibility of a soft-landing and created expectations for rate-cuts, commodity prices rallied (inflation) until the Fed stepped in to quash recession talk. Dubious job and consumer sentiment numbers have been called upon to re-establish the softly moderating economy. Odds of a rate-cut in January, which were as high as 50% in recent weeks, are now in the 10% range. Today's hawkish language took down the indexes, but also commodities because both have been riding on an expectation of increased liquidity in the form of a near to mid-term rate-cut. As mentioned in this thread previously, bulls have become skeptical of the goldilocks scenario and where they have rallied in all environments previously, they now want more assurance before they can continue buying at these nominally high levels. What's important to remember about this Bernanke Fed is that their data reliance means they can potentially turn on a dime.
In other words, while it must look credible in talking about rate-hikes and inflation fighting today, it can still cut rates at virtually any future meeting.

While silver has outperformed oil in the past three months, this has only meant losing less. A comparison of the 3m charts of USO and SLV show the two commodities trading virtually in tandem. To the extent this relationship stays consistent, silver is moving on macro-economic news. Downside from here is probably limited, though mining stocks could be under considerable pressure in the period between a severe downturn in market outlook and confirmation of a benevolent Fed. That said, with the election less than five weeks away and a decisive Democratic sweep potentially marking a massive buy signal in commodities, action in silver is looking more and more like final consolidation before a significant new move upwards.

[oroborean]

For rate-cut expectations to reignite, and with it the broad commodity bull, the major stock indices probably need to trim their recent gains, earnings need to slow and the overall market picture needs to deteriorate in the mainstream view.

This point should probably be clarified in light of today's strong action in both stocks and silver. The thesis of this thread is that the spot price of silver on a day to day basis is influenced by macro-economic forces such as economic outlook and the Fed's stance on interest rates. With that in mind, it seems unlikely that silver would stage a massive surge upward in the near to mid term if prevailing market conditions are antagonistic. On the other hand, market conditions could certainly become favorable for silver and start the sort of sharp rotation into commodities that would result in a super spike.

Basically, today's beige book was about as neutral as it could be. Most likely, the market rallied on the good news of strong earnings, high oil and gas inventories and no inclination for the Fed to raise interest rates. Significant for silver investors is that the beige book confirmed lower inflation expectations and lower inflation. This is an absolutely necessary condition for the Fed to actually cut rates, which would actually be the most bullish scenario for both stocks and commodities. The obstacle, however, is evident in the strong sales of inflation adjusted treasuries today, which seems to indicate that bond traders, at least, are not yet convinced that inflation has been tamed.

So, the idea in the quote above is that while things still look good (as we would expect given we're still pre-election) things will have to get a bit worse in commodities and stocks for the Fed to cut rates and really send both racing to the moon. This is not to say we need the market collapse for which some equities bears are still holding hopes. But, if economic outlook should deteriorate, with inflation still low, the Fed could cut rates to head off a possible recession before it happens. The extent of the sell off will be limited to the period of time between when a recession becomes likely and when a rate cut seems imminent, which could be weeks, days or merely hours.

In the meantime, silver may continue to stay rangebound, between $11-12, or even retake its recent highs above $13. But, the next major move will probably not happen, at least not at the pace we saw earlier this year, not in the next year or two, unless market conditions become supportive. And this means economic outlook first has to get worse and inflation has to at least appear to be contained. The alternative is that the economic outlook gets very bad very quickly and forces the Fed to cut rates even in the face of strong inflation and, while some gold and silver bugs may actually want this scenario, it is probably better to be prepared, but hope this sort of turbulence doesn't happen.

[oroborean]

If nobody minds, I'll continue updating this thread until the election. Thinking out past that, the Republicans already seem to be accepting at least a moderate defeat next month, but Bush still needs a healthy economy to have any shot at a positive legacy and for tax-cutting-as-economic-stimulus to have any sort of credibility. In the long-run, this is more important than wrecking this rally to make Democrats look bad (they can save that for '08 should a Dem take the White House). But I digress.

An interesting divergence occurred today. That is, commodities were down, but several mid to large miners were up. Well, it's no secret (if you've been reading this thread) that silver was down because rate-hike expectations are back in the news. Naturally, the dollar was up and commodities were down.

But why then would miners be up? Simply because the outlook is now becoming so bullish that money is coming out of bonds and out of cash accounts and is lifting all boats. Silver isn't getting hurt bad enough to stop traders from lifting valuations of the miners in this shiny, happy market. Is this beginning to sound like a market top? Of course it is. Does that mean it's time to short stocks? Absolutely not!!

Even though the fact that a rally in blue-chips could indicate a somewhat cautious, if not defensive, stance, and that recent volume and the number of stocks making new highs show an aging bull, this runup could still have considerable legs. "Silver bugs" should know as well as anybody that in terms of inflation-adjusted dollars, these new dow highs aren't really highs at all. If I had to guess, I'd say we're going to take a shot at some actual highs, if not now, then by certainly by the end of the Bush administration. With other national banks tightening, even just a prolonged pause will have the effect of slightly inflating the dollar relative to these other currencies, so there might not be any pressure to actually lower rates for some time. Until that happens, probably not until early to mid '07 at the earliest, silver is going to be rangebound and under pressure, while miners can expect to do reasonably well at these historically high prices as long as the equity picture does not turn sour or supply/demand in oil, gold or silver doesn't shift dramatically. This outlook changes, of course, if there is a significant terrorist event, an economic collapse, or a new war, but if this is what you're hoping for, you probably need to rethink your priorities (wait at least until there's a Dem in the White House).

Going into tomorrow's meeting, I'm looking to see exactly what the market is expecting: no change in rates and hawkish language on inflation with the slowdown in the housing market not spilling over into the rest of the economy at this point. Look for a quick rally on the news punctuated by some profit-taking before the larger rally resumes.


UPDATE: I just reread this post and the ever watchful contrarian in me cannot help but say that maybe it IS time to short the S&P a little, maybe through the end of the year. I'm not a stock market analyst and I'm sure no one here is taking stock advice from me, but just for the record's sake, I would say that obviously a market correction here would bring down mining stocks regardless of silver action and that silver itself would probably remain under significant pressure unless there is reason to think the Fed will cut interest rates and that global demand is staying high. All in all, it looks doubtful that silver is going to mount a significant run here in the short term and that stocks, a possible near term correction aside, still have a lot of room before they reach inflation adjusted highs. Go figure.

[oroborean]

The typical view today seems to be that the Fed statement today was virtually meaningless, and maybe for the larger markets it is. To my ears, listening on behalf of silver, it almost sounds as if the Fed just opened the door for a steady drift higher in commodity prices and sent us a buy signal.


Readings on core inflation have been elevated, and the high level of resource utilization has the potential to sustain inflation pressures. However, inflation pressures seem likely to moderate over time, reflecting reduced impetus from energy prices, contained inflation expectations, and the cumulative effects of monetary policy actions and other factors restraining aggregate demand.

First, the Fed still views oil prices as low, which takes some pressure off. Then, in addition to saying the economy is actually going to grow at a moderate pace, the forecasts a continued"high level of resource utilization". Sounds bullish to me! The real kicker, though, is that the Fed seems to be letting itself off the hook by saying that the coming rise in oil and commodity prices will not necessarily be seen as inflationary. That's about as sure a sign as I could expect that commodity prices are moving higher!

If I had to speculate on this development I could think of many factors that might have gone into this new stance towards commodity prices. First, it's possible that the Fed was not surprised, as the rest of us were, by the low oil inventory numbers today. If, as some believe, part of the reduction in price and rise in supply was due to the federal government postponing the purchase of crude destined for the strategic petroleum reserve. If that was indeed the case, and the recent draw down was the result of a return to normal buying patterns, then the Fed may have been aware that oil was going to trade higher today. Also, as many believe, if the Fed is working in concerted action with market makers, and other firms that may even be a part of the PPT, to depress gold and silver prices while propping up the dollar, then this could be an admission that their success could only be temporary at best. Being that we're drawing very close to the election now and Bush got his "the economy is important" sound bites in time, this seems to mark the beginning of the end of the pre-election Goldilocks run. This is an observation for precious metals markets, however, and not an opinion on stocks.

There was a steep dip in silver leading up to the Fed statement, which may have been a reflection of hawkish expectations. As we've seen, silver recovered and went higher as the statement is not only NOT hawkish on inflation, but actually seems bullish for commodities!! The rate odds in the bond market confirm this view, as expectations are still for a rate cut by the end of 2007.

[oroborean]

Today we're seeing the pronounced diversion between metals and oil I've been looking for. It's not a trend yet, but if it continues it is definitely the beginning of the next major move up!!

To read my latest views on silver and the Fed, read my article here (http://safehaven.com/article-6189.htm) on safehaven.com.

[oroborean]

The fact is that silver will continue to be subject to wild fluctuations at least through October, but probably through the New Year, after which the White House will once again ramp up it's Iran invasion rhetoric, oil will perk up again, the Fed will contemplate cutting, the dollar will drop, and silver will soar!!!

This was posted in October. So far, we've gotten an escalation in Iraq with rhetoric reflecting a possible attack on Iran. Oil could go either way, but with new carrier groups heading for the gulf and 20000 troops on call to Baghdad it's hard to imagine we'll see $45 like some are saying now and if we do, it won't last for long. The Fed still looks more likely to raise than cut, but everything is going its way so that if it needed to cut in a pinch it probably could. My bet is that oil, gold and silver had to be taken down prior to an escalation of violence and geopolitical tension so that when they inevitably go up again it won't be so much as to break the bank. If it gets desperate, though, the Fed will cut, of course.

[richiedoc]

My bet is that oil, gold and silver had to be taken down prior to an escalation of violence and geopolitical tension so that when they inevitably go up again it won't be so much as to break the bank.

The question is How oil, gold and silver stc. were taken down.

Short selling?
Goldman Sachs Commodity Fund change forcing compliance from large institutional holders?
A couple of traders in each of the pits with instructions?
Precise knowledge of stops and margins and the cash to short or buy just enough contracts to flush them out?

Problem is they get right back in within days...or hours.

The volume in the last week in the silver market is at an all time high. At least according to the Dukascopy chart.

[richiedoc]

Gee..look what happened on the 5th:

http://www.kitconet.com/charts/metals/leaserates/ag_go_0060_lsb.gif

Jan. 5 was last Friday...when part two of the recent plunge began.

Case closed. The market is rigged. ;)

[richiedoc]

Glad I posted a live chart above. Look how lease rates have suddenly gone back up! Now all the people who got free silver to short the market are gonna have to think about how to buy it all back for less over the next month-year.

:D:p