Gold and Silver Kneecapped

Addison Wiggin – May 4, 2011

  • Silver tumbles below $40… Alan Knuckman on the Merc's margin requirements
  • Gold corrects on the way to $4,000 (per John Paulson)… or would that be $8,331?
  • Service sector slams on the brakes… The number that sent stocks reeling
  • From taxes to TVs, economy reaches milestones last seen during the 1991 recession
  • "Bewildering, mind-numbing nightmare"… Frontline tale of a post-crash mortgage applicant

Following record highs set Friday gold, silver and a host of other metals are taking a dive this morning. From Friday's record close, gold is down $63 to $1,514.

Silver is down over $10… nearly 20%.

More than a third of silver's tumble came yesterday when it gave back $3.50 an ounce, to $41 and change. Yesterday was the worst one-day drubbing since the grey metal's epic fall from $50 in 1980.

Silver's given back a couple more bucks this morning…

The correction coincides with the Chicago Mercantile Exchange's third move in a week to increase margin requirements for traders.

"The heightened requirement is to ensure all trading parties are adequately capitalized for any price change," explains our resident pit trader Alan Knuckman, "The ones that get forced out by the new greater deposit mandates are typically on the wrong side of the market and hoping things change to make up losses.

"At present levels, a silver contract has a cash value of over $200,000 that is controlled by a deposit of typically only 10% or so. When prices have a 6-cent move, like we have seen, that translates into $30,000 between the daily high and low based on one standardized 5,000-ounce-size silver contract."

Silver topped at $50 in 1980. Today, adjusted for inflation, that would be $143.

Of course, that figure grants the Bureau of Labor Statistics the right to geometrically weight, hedonically fudge and substitute all kinds of skewed figures to get their numbers. If you used the consumer index, as the old school wonks did back in 1980 — and as our friend and contemporary wonk John Williams at Shadow Stats still does — you'd be looking at a silver price of $490.

Heh. Seriously.

We'd be surprised to see silver go reach $490, wouldn't you?

Still, there's ample headroom between the current silver price and the inflation-adjusted record. Long term, if you're a silver bull, the odds are on your side, even if it pulls back some more in the short term. Here's some guidance on how to play the trend.

Gold has shown more resilience this week. At last check, it's still higher than it's been anytime up until… hmm, let's check the chart… two weeks ago.

Still, the known big buyers and sellers of the yellow metal are making for an interesting trading environment currently.

The gold price is being pulled down, for example, by news that George Soros is cleaning out some of his considerable position.

The trade hasn't shown up in a 13-F filing — because that will be issued later this month — but The Wall Street Journal claims "the Soros fund has sold much of its gold and silver investments over the past month or so," according to "someone close to the firm."

As authoritative as that sounds, the story the WSJ tells is that Soros loaded up on gold to guard against a collapse in consumer demand after the crisis. Gold, the theory goes, would buy more if prices were falling. But now that the Fed has loosened the monetary spigots, and will keep dribbling even after QE2 wraps up in June, Soros does not fear "deflation" so much.

Likewise, if he's selling his gold, he doesn't think "inflation" is much of a threat either.

Alan Fournier of Pennant Capital is unloading some of his gold too, most likely to take profits as the market gets jittery near this false peak.

Meanwhile, John Paulson is happy to take the other side of the trade… which is helping keep a floor under gold.

The man who made his fortune shorting subprime told investors yesterday that lax monetary policy from the Fed, and the Bank of England, has him convinced gold will head to $4,000 an ounce over the next three-five years.

Mexico's central bank added 93.3 metric tons of gold to its reserves in February and March.

We haven't seen a number like this since November 2009, when India happily snapped up 200 metric tons of the International Monetary Fund's gold stash. Most of the Mexican purchase — 78.5 metric tons — came in March, marking the single largest one-month accumulation by a central bank in 10 years, according to the World Gold Council.

Combined with steady purchases by China and Russia since 2003, the news "seems to confirm there's an appetite now among emerging economies with large forex reserves to add to their gold reserves," says Matthew Turner, precious metals strategist at Mitsubishi.

Central banks worldwide became net buyers of gold last year for the first time since 1988.

Using the government's current CPI calculation, gold would be priced at $2,442 today. And using the government's 1980 CPI methodology, we'd be looking at $8,331 — a tad more ambitious than John Paulson's $4,000.

With gold prices like this, tiny miners that can pull gold out of the ground for $400 or $500 an ounce should be making fortunes.

Chris Mayer has two such miners in mind. The price doesn't need to fly anywhere near $4,000 to make good money. Heck, gold could stay where it is right now and one of these picks — trading at $1.73 — has the potential to zoom up to $27. Chris shows you how right here.

Stocks are tumbling. The major indexes are down three-quarters of a percent. The S&P has fallen back to its previous high of 1,344 in February. Traders appear to be throwing a snit over two figures this morning:

The payroll firm ADP says private employers added 179,000 jobs last month.. Considering it takes at least 100,000 jobs just to keep up with the natural expansion of the labor force, it's a less rosy number than what the Street was looking for.

Combined with last week's uptick in first-time jobless claims, it doesn't bode well for the monthly unemployment figures due Friday.

The service sector of the U.S. economy is slamming on the brakes, too, it seems. After turning in a healthy 57.5 on the ISM nonmanufacturing survey in March, the figure tumbled to 52.8 in April.

We like the anecdotal reports that come with the survey better. They're more revealing:

  • "Looking forward with reserved caution. Cost of goods by this fall are a big worry," says one…
  • "Fuel prices continue to be challenging, and, in addition to shipping, are influencing the cost of materials," conveys another…
  • "Continuing economic uncertainty will curtail or delay project spending for the immediate future." Really…

If May shapes up like April, the service sector will shrink for the first time since August 2009.

The terms for Portugal's bailout from by the European Union and International Monetary Fund are slowly emerging. Looks like they'll get $117 billion over three years. No word on the interest rate, but Prime Minister (with a cool name) Jose Socrates is hinting that Portugal got better terms than Ireland and Greece.

$17.8 billion of the total, a little over 10%, will go directly to Portugal's banks to shore them up.

As is often the case, clarity helped the euro firm up to its best position vis-a-vis the dollar since December 2009. It's currently at $1.486.

We remember fondly warning our friends in Paris when the euro began circulating among stores that it would not only hit parity with the dollar… but go to $1.50. It started life at $0.82. Back then, everyone we knew just laughed. Gold was trading at $288, too.

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In the first of two "worst since the 1991 recession" figures we've run across this morning, we see a majority of Americans now avoid income tax altogether.

According to a new analysis from the congressional Joint Committee on Taxation, 51% of Americans paid no income tax in 2009. Unprecedented? No, it happened in 1992 too.

More shocking, perhaps: About 60% of that 51% actually collect money from Uncle Sam via tax credits.

The number of U.S households with a TV set will likely fall this year, according to the TV ratings firm Nielsen. 98.9% of U.S. homes have a TV this year; the figure is expected to contract to 96.7% by next year.

Lest you think this is about iPads and other tech advances, think again. The last retraction in TV set permeation occurred 20 years ago.

"As with previous periods of belt-tightening, the cost of owning a TV is a factor in this… decline," says Nielsen. "Lower-income, rural homes were particularly affected."

People who can't eat iPads can't afford to replace their old analog TVs either

"The evidence suggests that what we're seeing is a function of poverty more than it is technology," says Craig Moffett of Bernstein Research.

We recall two years ago when over-the-air TV stations finished their transition to digital broadcasts, the government offered $40 coupons for folks who didn't have cable or satellite to buy converter boxes — so their old TVs would still function.

Now that those TVs are giving up the ghost, we sense a new "cash for clickers" program coming on…

"Social Security recipients should stop whining," a reader writes after yesterday's discussion about cost-of-living adjustments. "They received an unearned 5.9% CPI increase around September of 2008 caused by the temporary oil shock of that summer which quickly collapsed in the fall.

"2011 is the first year that prices in general are noticeably up. Social Security should receive an increase again in September. That will be more than the rest of us are getting."

"I am one of the unfortunates running the gauntlet of a mortgage loan application. Per my CPA, if I were a fry cook in a line camp somewhere, there wouldn't be a problem.

"That being said, you should know that I am a realtor of active experience for 40 years, having been licensed in five states and having weathered any number of 'corrections' in my career. So I do have a wealth of experience in all sorts and manners of loan application, as well as loan applicants.

"Never in my entire career, though, have I ever experienced ANYTHING approaching this current experience!! It has been a bewildering, and is fast becoming a, mind-numbing nightmare!! Apparently, a very good credit score, assets in the bank, cash on hand, stable credit history, no bounced checks and decades of employment and taxpaying to Uncle Sam don't carry much weight anymore.

"How is all of this going to end for me? Honestly, I don't know, nor am holding out much hope. My CPA has 10 other clients jumping through the loan application hoops at this very minute. So it's safe to presume that one of the key reasons mortgage applications are dropping is the hell one goes through to try to get a loan!

"Before real estate activity can begin again, there must be a buyer that can reasonably expect to get reasonable loan application treatment from a lender!"

The 5: What does the fry cook have on you?

Regards,

Addison Wiggin
The 5 Min. Forecast

rspertzel

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