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Prepared by Philip Gotthelf

Gold… Sooner Rather Than Later

(September 3, 2015) This past weekend ISIS released a video calling for the “dawn of a new age” with the following statement, in which replacing the dollar with gold would deliver “the second blow to America’s capitalist financial system of enslavement … casting into ruins their fraudulent dollar note.” According to ISIS propagandists, Western currencies are a great conspiracy to steal the wealth of other nations… in particular, Islamic states. They claim that the United States manipulates worthless paper to control the destiny of “true believers.” The pitch is extraordinarily professional with a logical explanation of how gold can be fractionalized into spendable currency or converted into jewelry as a store of wealth. Overall, the presentation is top notch even for Western viewing.

I was not expecting to see this public pitch so soon and I find it surprising that ISIS would not want to wait until gold might become more affordable. Then it dawned upon me that ISIS already owns substantial gold holdings and they are probably trying to maintain value so that they can use metal as currency. Although supporting gold may be the preliminary objective, I was surprised to see ISIS publically explain their currency strategy within the context of a “second blow” to our capitalist system. Has anyone asked about the first blow? The reference would not be to 9/11 because ISIS was not involved in that endeavor. It is conceivable the reference is to the current stock market volatility, but I am reasonably confident the video production predated the past two weeks of market instability.

From former FED chairman Alan Greenspan to respected alarmists like James Rickards, there is a clarion call for the Gold Standard. Having been short gold for the last downward leg, my previous attempts to reverse and go long failed, resulting in losses. It is difficult to buy gold and silver when raw commodity prices are collapsing. Yet, there are strong indications that physical accumulations are accelerating. As mentioned in previous REPORTS, China, Russia, Saudi Arabia, and other nations generally outside the Western sphere are stockpiling gold. Whatever the market throws at them, they remain buyers.

I am not convinced the transition to gold will necessarily come violently. I would like to think we can see a calculated more toward tangible currency through some form of linked mechanism similar to Bitcoin. I am in the minority. Most books about a gold revolution preface the move with a collapse in the paper system… an ISIS objective. Whether it is the multi-trillion dollar U.S. debt or the European counterpart, the gold argument has generally been based upon the lack of monetary discipline and historical precedents. When governments get into monetary trouble they debase their currencies to pay back debt. Now, more than ever, the printing presses have been activated to stimulate economies without regard for the potential consequences.

No one seems to consider structural changes to gold and silver that include increased mining efficiencies and decreased industrial demand for silver, in particular. I have pointed out that the most significant application for silver in film has faded into near oblivion. Back in the day, 40% of new silver production was dedicated to photographic film. Today, everything is digital. Batteries, mirrors, and solar panels have filled the photographic void to a modest extent. The point is that less industrial silver demand bodes well for more use as currency.

The “copper penny syndrome” is the model most frequently cited when it comes to silver. This is to say that a silver dollar costs more than the face value. If a 1-ounce silver dollar were implemented, people would hoard the coins and melt them for profit on the physical metal. Here’s where the ISIS model comes in. ISIS suggests a variable coin size commensurate with the metal’s price. To be sure, such a system would be extremely awkward. So, ISIS and other Middle East states continue wrestling with the gold standard construct, dragging silver along for the ride.

October gold staged a nice rally from August lows around 108000/oz to hit 117000 just before September. This 8.3% move came even as crude oil jumped more than $10/bbl; a 25% gain. Oil traders are cheering and I was pleased to participate from our 4216 entry until we were stopped out at 4421. Once again, the timing was right and the strategy was correct, but volatility exceeded the calculated risk parameters. I am not complaining about a 41% profit, but we would have made twice as much if I had been less conservative. By contrast, gold has dipped below our entry today (Thursday), turning a nice profit into a small loss as I write.

The Oil/Gold Connection

I have been emphasizing the connection between petro-dollars and gold. The ISIS position has surfaced, proving my prognostications. With the Obama Nuclear Deal inked, Iran will receive more than $150 billion in withheld cash assets. As I have said, Iran has no interest in risking another dollar asset confiscation. As far as I know, there are no strings attached to the returned funds and no constraints. John Kerry and his negotiators did not think constraints were necessary. This means that any portion of the $150 billion can be used to buy weapons or convert to gold.

As oil prices rise, purchasing power increases. Since oil is priced in U.S. currency, the stronger Dollar provides an extra kicker that is only partially offset by the simultaneous rise in gold. I see petro-dollar conversions into gold by all Middle East OPEC members, not just strong ones. For example, Libya has taken delivery along with Syria and Nigeria. Saudi Arabia has been active and there is evidence of gold transactions between Russia and Iran. In the world of Shiites and Sunnis, gold is a constant. Respect for gold is mutual and the ISIS plan is likely to be replicated by Iran despite all other philosophical differences.

This week saw mixed messages about crude supplies that spiked prices higher. I cautiously placed a buy stop at 4216 when October crude oil was trading below this resistance. I did not want to risk inter-day volatility ahead of inventory numbers, but I suspected an oversold condition and anticipated a powerful breakout if 4216 could be taken out. It was and the results are self-evident.

The daily October crude oil chart shows a 50% retracement from the May high to the August low. The technical debate is whether the current downward flag represents a retreat from the 50% mark or a continuation pattern that will carry prices to the 5700 gap made in the beginning of July. Chartists like to say that all gaps fill. The problem is, “When?” Notice the gap left last November on the way down. That gap at 7300 is not likely to fill anytime soon.

Yesterday’s inventories were up to suggest the prior data was misleading. Most of the price rise is attributed to suspicions that OPEC will cut quotas to support the market. The problem with this is the very status of OPEC whose members are no longer unified in a common cause. Who is going to be the first to cut back production? The Saudis? Iraq? Iran? Kuwait? Qatar? UAE? Nigeria? Libya? Venezuela? I don’t think there is any uniform resolve to self-sacrifice for the greater good.

If we have a 50% retracement, now is the time to resell. The implication is that prices will retrace to test 3800 lows and decline another $5 representing 50% of the retracement… a 3300 target. Imagine that! Crude oil being close to the twenties! Perhaps the most significant pressure being applied to OPEC derives from the following:

--South Africa is pumping 91,000 NEW barrels per day

--Gabon is pumping 241,700 barrels per day

--Republic of Congo is pumping 274,400 barrels per day

--Equatorial Guinea is pumping 346,000 barrels per day

--Sudan is pumping 487,000 barrels per day

--Egypt is pumping 680,000 barrels per day

--Libya is pumping 1.7 million barrels per day

--Angola is pumping 1.9 million barrels per day

--Algeria is pumping 2.1 million barrels per day

--Nigeria is pumping 2.2 million barrels per day

Out of this list, only Libya and Nigeria are OPEC members. Almost all the Sudan’s oil is exported as are the rest of the list. Many resources are new… within the last five years. Output is growing and African oil is a direct challenge to OPEC’s dominance. Still, there is the persistent presumption that low oil prices have driven producers out of business. Look at this from an historical perspective.

From 1999 to 2005 crude oil prices were contained below $40/bbl. From 2005 into 2008, prices inflated by 207%, but by 2009 the price touched below $35/bbl. In 2005, it took only five months for crude to collapse from $148/bbl to below $35/bbl. This is unprecedented volatility that demonstrates the potential. Crude oil declined from $105/bbl to $45/bbl in seven months through January 2015.

Look at the numbers. The Oil Patch must contend with rapidly growing new production and static growth. This is not to say that demand cannot rise. I am talking about proportional price reactions. This is why gold appears stable compared with consumables like crude oil. The United States does not need to import crude oil. Based upon consumption trends and projected domestic output, Big Oil needs to make rapid changes that are not necessarily restrictive. Like OPEC, domestic producers must weigh the cost of production against profit margins. Since efficiencies are increasing, the pace of demand growth may actually turn negative. This means the strategy must turn to maximizing market share.

Yesterday, I passed by a gas station posting a $1.99 99/100ths price for regular. This was in Northern New Jersey. Who would have predicted regular for under $2.00/gallon? Refinery capacity utilization is down even as we approach the heating season. The switch is already in progress from gasoline to heating oil. After this weekend, summer driving season is officially over. There will be a last spurt for the foliage season and then it’s back to hibernation.

No Raise for Rates

The FED remains undecided about its September rate hike, but the Dollar has rallied in anticipation. The European Central Bank is open to further easing which has brought enthusiasm back to the Greenback. A strong Dollar should mean weaker gold. That did not happen in the prior Dollar rally. I mentioned that gold was actually rising in real terms because the Dollar was strengthening.

If stocks markets are reflecting China’s difficulties, I do not see how stalling on interest rates helps China. It may be true that the combination of the soft Yuan and strong Dollar increases China’s strategic position, but I am not sure the effect can be immediate or even anticipated. If the FED believes job numbers are weakening and the U.S. economy is slowing down, keeping rates low through the winter makes sense. But, if the purpose is to prop up stocks, there is no direct correlation. By the time the stronger Dollar and weaker Yuan catch up to corporate performances, the entire global picture can change. China’s bubble has little to do with the U.S. or Europe. They are simply overextended.

There is a general paranoia about October based upon the 1929 and 1987 crashes. Perhaps the correction came early in 2015. I can say this… I suspect volatility will continue.

September 3, 2015
Philip Gotthelf
Commodity Futures Forecast
P.O. Box 566, Closter, New Jersey

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