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Commodity Futures Forecast

The “Crash of '97” has materialized, however, it is in Hong Kong and Asia rather than the United States...for now. China is rapidly losing its grip on its new territory and global repercussions could be significant. The key element to Hong Kong's “ripple effect” will be the degree of forced liquidations in other financial markets. If Hong Kong investors are forced out of markets in the U.S., Canada, and Europe, prices can retreat on a global scale.

The alternative argument is that Hong Kong money will flee to U.S. equities and government paper for safety. Where else can they place their money? This makes sense, but we must consider the political environment. I am inclined to believe money will flow into our markets rather than out. Yet, I am not sure China is willing to allow a free flow of its financial resources out of the country. In addition, my sources indicate Hong Kong's financial elite do not want to anger China with a display of “no confidence.” Culturally, we may see the ultimate financial sacrifices made by Hong Kong simply to save face.

This morning, traders were referring to the “Asian Meltdown.” Hong Kong has been the financial arm for much of Southeast Asia. The competition for position has been with Japan. This places the entire Pacific Rim at risk because exposures for both Japan and Hong Kong are enormous. The slowdown in Indonesia, Malaysia, the Philippines and associated regions has challenged currency values. To defend, interest rates have been hiked and the death knell for stocks has sounded.

As with all crises, there is a path to recovery. However, nerves are on edge because the spill over to Western markets is clearly possible as indicated by global reactions today. Just last week, the S & P 500 and other indices were decisively bearish with very clear consolidation tops that threaten a 10% to 20% correction if used as a measuring indicator. I stated in my previous report that there was nothing within the domestic market that should precipitate as crash similar to 1987's Black Monday.

However, traders are a fickle bunch. It is possible for Asia to bring down the world. Assuming China's leaders have enough common sense to allow a Western market showdown to play out, the situation should be self correcting. If restrictions are imposed, panic will follow and the environment will remain unstable for a longer period. The question of strategy is difficult.

Inter-market volatility has been too great for most investors. Even the “big boys” have been suffering through each massive gyration. Charts continue with trading range conditions despite the “near break-out” associated with this week's earlier recovery. Last week, the yen appeared to be making a bottom. This week, there may be no bottom. If support at 8230/8240 is challenged, a test below 8000 is technically indicated. How low can the yen go? While many traders recall the lofty heights of futures above 12000, the Japanese Finance Minister said anything above 6500 was too high in the mid 1980s!

It is not in the world's best interest to allow the Japanese to fail financially. As with all similar situations, the key to a bail out is clandestine action. By allowing the yen to drop against the dollar and European currencies, they can increase exports to shore up the economy. This is similar to manipulating U.S. interest rate spreads in favor of banks during our own liquidity squeeze. While consumers paid the difference, banks were bailed out without overt action.

Traditional thinking would support a bullish consensus in gold and, perhaps, silver. This may have captured interest this morning, but price hikes quickly faded by early afternoon. Caution is in order because gold tends to be the first sacrifice to gain liquidity during modern economic uncertainty. This goes against the grain of all historical perspectives, yet we cannot deny the latest empirical facts...tradition is out the window!

Meanwhile, Ted Arnold of Merrill Lynch claims a “squeeze” in silver may be brewing. According to Bridge News, Arnold believes hedge funds are about to join forces to control nearby silver deliveries. If his analysis proves correct, silver could be bid up to $8 or $9 an ounce. Arnold points to recent palladium action as an example of a squeeze. What's wrong with this picture?

First, palladium demand is up while supplies are static. Demand for catalyst applications, electronics, chemical use, and even dental alloy is up while Russia's contribution is legitimately down. I do not believe Russia is squeezing palladium and open interest patterns don't point to any large fund participation. The reality is that the metal is worth the price. Arnold should keep in mind that the amount of palladium and number of producers is small compared with silver. The three major palladium producers are Russia, South Africa, and North America. If Russia drops out, one third of the supply evaporates.

Silver has more diverse sources. Producers like Peru, Mexico, and Chile would be hard pressed not to sell into any major rally above $6. The market has failed from this point too many times in recent history. Further, we don't know how much producer inventory really exists. Volatility is still an issue. With the exception of gold, we are using options in the metals to provide a more conservative approach. There is always the possibility metals will respond to a deepening of the Asian market weakness.

October 23, 1997 Philip Gotthelf

Commodity Futures Forecast

7000 Boulevard East, Guttenberg, New Jersey

Financial Commentary

THE ALLENDALE ADVISORY REPORT | STRATEGY FOCUS | WEEKLY OUTLOOK
ECONOMIC PERSPECTIVE | FED STEER PRICES GOING NOWHERE FAST
U.S. ECONOMIC AND INTEREST-RATE OUTLOOK
STICKING WITH THE U.S. TREASURY MARKET | THE TODD MARKET TIMER
CASH AND BONDS-- THE RODNEY DANGERFIELDS OF FINANCIAL ASSETS?
MYERS ON FUTURES | THE COPPER JOURNAL | COMMODITY FUTURES FORECAST WEEKLY REPORT
INTEREST RATE WATCH | NIKKO MARKET COMMENTS

Consensus National Futures and Financial On Line Index

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