Weekday Commentary from Jim Puplava
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Market WrapUp for the Week
Monday l Tuesday l Wednesday l Thursday l Friday
The Week in Graphs 
Storm Watch 
Geopolitical News 
Energy Resource Page 
Precious Metals 
Raw Materials
Friday, October 4, 2002
Geared and Engineered
Webster’s Dictionary defines manipulate as follows, ”to manage or control artfully or by shrewd use of influence, often in an unfair or fraudulent way, or to falsify for one’s own purposes or profit, to cause (prices of stocks, etc.) to fall or rise by wash sales, matched orders, etc.” Webster’s definition of “manipulate” certainly might apply to today’s financial markets. The seemly strange gyrations in the major stock indexes and the large short paper positions in commodities appear contrived and unnatural. A euphemism often bandied about Wall Street these days is “managed.” Certainly, market days, like today or Tuesday of this week or Tuesday and Wednesday of last week, appear out of sort with the financial markets. As viewed from the graphs of the S&P 500 and of the Dow above, the major averages have come close to key support levels, which have now become the July lows of 775 for the S&P 500. Another key support figure is 815, which is a key Fibonacci number and a key support number that held before the July lows on the S&P were reached. Each time the index gets to these levels, we tend to experience one-day miracles such as we had this week on Tuesday. These key support levels have become the new Rubicon for the financial markets. Once crossed, "Look out below!," seems to be the thinking.
The S&P 500 formed a “Head & Shoulder “ pattern and every effort has been made to keep prices above the neckline as shown in the graph above. Tuesday and Friday of this week experienced miraculous upsurges as Rubicon points were crossed on the charts. Usually some lame excuse or reason is given for the upsurge. Last week's mini rally was attributed to GE meeting earnings estimates. Then the downturn gathered momentum a few days later as GE announced that meeting profit targets for next year were going to be rough. The big surge on Tuesday was attributed to good news on Fannie Mae, Verizon, and Forrest Labs that their earnings wouldn’t be as bad as expected. The Dow rallied 347 points, the S&P 500 33 points, and the NASDAQ gained 42 points. I don’t know of any rational-thinking human being who would rush in to buy stocks just because a company’s earnings wouldn’t be as bad as originally forecasted. The repeated mantra was that stocks have fallen down enough to make them cheap again. P/E multiples of 20 on the Dow, 30 on the S&P 500 and 37 on the NASDAQ aren't cheap in my book. Stocks are still grossly overvalued -- more so when you look at real earnings according to GAAP (Generally Accepted Accounting Principles) and not the CRAP (Cloudy Reporting Accounting Principles) numbers that are so widely used today.
Today's Investors Are NOT Lame Brains ... They're Getting Smarter
The problem that Wall Street has is how to keep investors fully invested and avert attention away from the exit gates. The second-half recovery isn’t going to take place. Pro forma forecasts for miracle earnings for the third and fourth quarter were a mirage and have been thoroughly discredited. So what line of balderdash is next? The recent drop in the major indexes reflects an adjustment process. The mirage of a second half recovery isn’t going to take place and stock prices are adjusting for this reality. Fourth quarter estimates still remain too high from forecasted earnings. Another adjustment process is needed. It remains a question on whether it is allowed. As already mentioned, every time stock prices fall below key support levels, a miracle one-day recovery appears along with some lame excuse to justify it. Apparently Wall Street assumes that most investors are idiots and uninformed. However, they are playing a dangerous game. This year is already shaping up to be another year of double digit losses for investors. Most funds have consistently lost money for their shareholders. What do you do when stock prices are heading back to levels that we haven’t seen since 1995 or 1990? And what do you keep telling investors as a reason to hold on to what they own? The CEOs and corporate insiders have already sold off their shares years ago. Wall Street trades and shorts the market; while they tell investors to buy and hold.
Judging by money flows out of mutual funds, investors may not need much more than a shove to head for the exit gates. That is why the line in the Rubicon has been drawn in the charts and every effort will be used to maintain it. It remains to be seen whether the laws of gravity can be repealed. In the end, history teaches us that the markets will have their way. What I suspect will happen is that some 10-sigma event, not programmed into the computer models, will suddenly appear and it will overwhelm the markets despite the best efforts to thwart it.
When you squeeze lemons, you get lemonade
When you squeeze the shorts, you get a bull market.
Silver Producers Held Hostage
Just as there has been an effort to maintain and put a hold on stock prices, there appears to be another unnatural effort to keep bullion prices and the share prices of precious metals companies down. I covered a portion of this yesterday when I talked about the huge short positions in five key silver stocks. There are less than 10 key producers of silver in the world. These companies are primary silver producers as opposed to base metals producers or gold companies that mine silver as a by-product. Silver stocks have fallen precipitously in July, and then again, after their rally from their July lows. The drop in prices corresponds with large short positions that have been taken in each and every one of these stocks. Like the large silver short position in the COMEX, they remain vulnerable to the efforts of any hedge fund looking to affect a squeeze.
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Shorting Silver |
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| Silver Producer | Short Position | Friday's Volume | Days to Cover |
| APEX Silver | 792,000 | 79,100 | 10 |
| Coeur d'Alene Mines | 3,881,000 | 526,400 | 7.4 |
| Hecla Mining | 2,405,000 | 391,000 | 6.2 |
| Pan American Silver | 1,00,200 | 201,525 | 5.0 |
| Silver Standard Resources | 874,000 | 190,960 | 4.6 |
A similar position now exists for the silver shorts. As the table above shows, short interest in most stocks would take between 5-10 days to cover. Since most computer screens would pick up on any change in volume, the shorts have to be careful of when and how they cover. They will have to use stealth to cover their tracks by buying back in slowly so as not to alert program trading monitors to any abrupt change in volume. If they tried to cover at once, the price would take off as it did in May and in June.
This buying may already be taking place as this chart of money flow indicates in Coeur d’Alene Mines. Volume has been slowly edging back up since the August bottom. Based on Friday’s trading, it would take the shorts more than 7 days to fully cover.
Something's Gotta Give For Silver
In addition, these stocks are at key technical support levels presenting a good buying opportunity to add to positions or to enter the market. As this long-term Kitco chart of silver indicates, the price of the meal is at rock bottom having fallen over 90 percent from its peak back in the last bull market of the 1970’s. Silver is scarce today and it is getting harder to find. The metal has been running a supply deficit for well over a decade and the government's own stockpiles of the metal have been exhausted. I recently had a long conversation with two geologists who have supported this view. There is one large silver mine potential in Latin America that may be difficult and expensive to mine. However, for the most part, very few new and large silver deposits have been discovered. Additionally, most silver is a by-product of base metal mining. As more base metal producers shut down mines, silver deficits should increase in the years ahead. At current prices of $4.49 silver is uneconomical to mine. Would your mining company explore for silver at these prices if you couldn’t mine the metal profitably?
Despite its historical role as money for over 5,000 years, the uses of silver as a key industrial metal keep expanding from batteries to water purification to non-pollutant marine paint. It may surprise most Americans, but around the globe in India, Asia, and the Middle East, silver is viewed as money. In many languages the word for money is silver! Most of the demand for precious metals is coming from emerging markets where precious metals are used as a form of savings and investments. In cultures much more ancient than ours, and who view and distrust paper money, silver and gold = money. It has been that way for over 5,000 years, despite the best efforts of statists to discredit it.
Click on the image to view the larger chart.
Silver is Undervalued in a Major Way
I have recently received numerous e-mails regarding silver's role in a deflationary environment such as we experienced during the Great Depression. We need a few facts first. During the Great Depression, there was surplus of silver in the country. Congress actually passed a law requiring the Treasury to buy silver. This was a period when the government’s great stockpiles were accumulated. After its nadir in 1933, silver actually performed much better than gold. Gold prices were capped at $35 an ounce. Charts and other fundamental aspects will be covered in next week's Wrap Up as supply dynamics begin to unfold in the months ahead. Simply put, silver is undervalued in a major way. Prices have been kept down through short selling since there are no large deposits of silver that can be loaned out to bullion banks from the vaults of central bankers. The only way to keep silver prices down is through the use of derivatives or paper contracts. Large supplies of the metal simply don’t exist. Mainly consuming above-ground stockpiles accumulated over decades has made up silver deficits. Those stockpiles will be running short over the next 18 months. The Treasury will have to go into the market to buy the metal for its silver eagle program. The Treasury purchase of 10 million may not sound like much until you add it to a 100 million plus existing supply deficit. One can only speculate as to how high it will go when gold and the metals take off as confidence in paper evaporates with each new oncoming financial crisis -- not to mention potential geopolitical rogue waves.
The smart money already owns silver. Buffett bought his stake in 1997. He took delivery and then shipped it to safe keeping overseas. Others such as Soros, Gates, and Tish have bought because they apparently recognize silver’s gross undervaluation. Gates already owns 11.8 percent of Pan American Silver, a position he has held and has added to over time. I also know of five other fund managers who own significant positions in some of the companies listed above. In fairness and part of full disclosure I also own some of these companies in my own account or for my clients.
This Week's Market - Crossing the Rubicon
In looking at this week's market, the S&P 500 lost 3.2%, bringing its losses up to 30.27% for the year. The Dow lost 2.3% with losses YTD of 24.88%. The NASDAQ seems to see no end to its hemorrhaging, losing another 4.9% this week bringing its 2001 losses up to 41.56%. The S&P 500 now sits at only 2 points above its five-year low reached in July. That is why there was a rally push late in the day to keep it above the Rubicon. The NASDAQ is now at levels not seen since September 6, 1996; while the Dow has fallen to its lowest close since November 13, 1997.
The real key for these indexes will come during the third week of this month when companies start reporting actual results for the third quarter. By then estimates will be lowered to such an extent that companies could actually lose money and beat estimates, as many of them will do. More than three out of four companies have already lowered their third-quarter profit estimates. Earnings estimates keep getting lowered by the day. We are now down to 5.9% from 6.3% earlier this week and 17.1% in July, and over 30% in January.
The markets were hit with a plethora of warnings today covering a wide swath of industries ranging from aerospace, banking, base metals, communications, drugs, to technology. The earnings disappointments are no longer concentrated in technology, but seem to cut across all segments of the economy.
Looking Forward
What the markets will have to face in October and November is not only disappointments for this quarter, but additional warnings for the next quarter and all of next year. GE has already alerted the markets to the fact that the company will have a difficult time maintaining double-digit earnings growth next year. More companies will follow GE’s lead. Better to get the bad news out early so that analysts can take their rose colored glasses off and lower their expectations. No CEO wants to cook the books anymore in this environment when long vacations at Rykers Island are now a distinct possibility. Indeed, the unrelenting flows of warnings all week long are revealing an ugly profit picture. They are making Wall Street projections for a third year second half recovery look ridiculous.
Upbeat Report on Fund Managers Positioned in Gold
The one bright spot this week was gold. In fact Investors Business Daily did a story about some of this year's most successful fund managers. The leading managers have been accumulating gold. The average gold fund is up 45 percent for the year compared to almost equal losses for the NASDAQ and the S&P 500. Precious metals have held the center stage since the bear market began in March of 2000. The top funds in performance this year are either short funds or gold and precious metals funds. This is a trend that has continued from last year. Wall Street doesn’t like to talk about the metals because they present competition for the markets. However, the smart fund managers have been buying and are outperforming the herd. Managers have been accumulating Gold Fields, Gold Corp, Glamis, Harmony, Meridian, and Agnico-Eagle. The common thread of all of these companies is that they are unhedged gold producers. They have consistently out-performed hedged producers. The difference in performance is shown in the producers such as Barrick and Placer Dome. Barrick is losing big money in its hedges as the price of gold rises.
The difference between hedged and unhedged companies is reflected in the performance of the HUI, which is up 83.17 percent in comparison to the hedged XAU, which is up 23 percent. This still compares favorably to the major indexes, which have lost 25-41 percent this year. At some point, heaven only knows when, the general public is going to get the message stocks are in a bear market and gold, silver and “things” such commodities are in a new bull market. This is a message that is constantly obfuscated by all of the noise over beating estimates, pro forma earnings and whether the economy is in great shape. The markets know better which is why they are down. Only John Q still believes the fairy tales. The smart money has left the markets and is buying the metals. Some day soon John Q is going to wake up to the fact that there isn’t a Santa Claus.
The VIX ended up the week at 46.28 and the VXN finished at 60.28. Volume picked up all week long on the sell side.
© Copyright Jim Puplava, October 4, 2002