5/3/09 Precious Metals Poised To Move Higher

Precious Metals Market Analysis, By Michael Pennington (Copyright 2010 Pennco Coins)

Trying to predict tops or bottoms in any market is extremely difficult, but it is especially true for the precious metals. One reliable statistic I have used in the past successfully is the number of open Call Options.  I have reported to you before  two large banks, probably JPMorgan and HSBC, are holding a huge short position in gold. As a result, it seemed prudent to check on the COMEX open interest. Figure 1 shows the cumulative Open Interest across all strike prices for the COMEX Gold Call positions and the Put positions for the JUN 09 options

If you read up vertically from any value of the strike price to the red line it says how many Put options are in-the-money at that price and on the green line the total number of Call option contracts that are in the money. For example, at a gold price of $750/oz a total of 40,000 Put option contracts would be in the money. For a gold price around $1000 a total of 60,000 Call options would be in the money. The ratio of Calls to Puts is 1.81 so Bulls outnumber Bears dramatically. What is also remarkable is the amount of open interest. For example, 100,000 contracts would be in-the-money if the gold price runs to $1250/oz in the next 30 days. This is an astounding amount of option OI considering the open interest in all the futures contracts stands at only 345,000 contracts!

I consider option players highly sophisticated speculators. Such large bets are likely being made by some large money interests who are buying out of the money options BEFORE going into the futures market. Buying long futures in large volumes will rapidly drive up the gold price but the massive open interest in the Call Options then allow access to much more futures contracts at the same price by exercising the options and then perhaps taking delivery of the gold. Connecting the dots seems to indicate JPM is likely trying to cover a chunk of their massive short position.
The situation is similar for silver. Figure 2 shows the ratio of Calls to Puts is 1.80 so Bulls outnumber Bears by 80%. What is also remarkable is the amount of open interest. For example, 18,800 contracts would be in-the-money if the silver price runs to $25/oz in the next 60 days. This is an extraordinary amount of open interest considering the open interest in all the futures contracts stands at only 94,000 contracts!

I conclude that smart money is betting on a massive rise in the gold price in the next 30 days and silver in the next 60 days (which probably means within 30 days for both metals) and again by December. I wouldn’t be surprised to see a pullback in between the two events. This money could not go in to the futures market without blowing the lid off the price as it would represent such a large increase in open interest. Going into the out-of-the-money option market allows flying below the radar.
The CALL/PUT ratio on the stock market is usually a contrarian indicator because the average, unsophisticated retail investor will buy options and the average retail investor gets it wrong and chases the market move most of the time. Only sophisticated traders tend to be in the precious metals option market so when there is a huge build up betting on a particular direction that is typically a directional indicator.
The flat contango in gold and silver suggests there is a shortage developing of precious metals for delivery. We know that these two large banks hold almost 100% of the commercial net short position. They need desperately to cover their exposure if the market is about to make a big move. It looks as if that is precisely what is happening.

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