Metals are something of a leading indicator for the economy. There are very few products that do not in one way or another depend on a metal in their production. (Cement comes to mind, but in use it is often combined with iron rebar; oil is refined using metal catalysts; plastics are made with metal catalysts, wood is cut with metal tools and shipped via metal vehicles).
For you to get a new iPod in a cardboard box, someone had to make the cardboard (and the saws that cut the trees) and refine the oil for the plastics (using catalysts) and ship it (using oil products in the fuels and metals in the vehicles). Then there are the metals IN the product. Nickle or Lithium in the batteries of different products (or lead in car batteries). Loads of copper wiring. Tin in the solder. The list goes on. Long before that iPod or new car reaches your hands, metals were mined and refined to make it possible. When an economic boom is starting, metals rise early. When the economy stalls, among the first things manufacturers do is cancel orders for raw materials and tooling. Metals take a dive.
When Daddy Warbucks (in Little Orphan Annie) sees a recovery coming, what does he shout into the phone? ~”Copper, Copper! Buy more COPPER!”
Well, the flip side is true, too. In a downturn, you don’t want metals. Recently, China announced lower production numbers. When China, who never says anything bad about China, says things are slow; well, they ARE slow. And metals promptly tanked.
So now the “bottom watch” begins. Is THIS the bottom? Or is it still to come?
My method depends on having prices cross over the Simple Moving Average, return to it from above, and fail to punch back through. That confirms the bottom. Until then, it is just another “counter trend rally” if prices rise. They usually rise to the SMA lines, and fall away again. But things are not always and forever. Eventually prices will ‘punch through’ and the trend reverses.
The typical pattern is a plunge, return to the SMA stack from below, a further plunge or two to a bottom. Then a rise through the SMA stack (the “Dead Cat Bounce”) and a return to the SMA stack from above with a failure to penetrate to the downside. Often there is a “ring down” where prices wobble back and forth with a generally flat trend as the bulls and bears fight it out and the range narrows. At the tip of that wedging-in process, one side wins. THAT is when you can place longer term bets, until then it’s just swing trading.
OK, with that preamble, what are metals saying now?
Lets start with Silver vs stocks and bonds.
Silver 6 month static chart with RSI, MACD and Vol+ vs Gold, Russel 2000, and Bonds
SLV is silver, RUT is the Russel 2000 broad stock index, and TLT is the long duration bond fund. GLD is gold.
Why start with Silver? Because it has been hyped a lot on the TV lately. My most basic silver and gold indicator is a contrarian indicator. When the TV ads are strongly pushing Gold and Silver, it typically means the metals sellers are having trouble getting enough customers. Pretty much everyone has already bought and it’s time to rope in the least savvy from the home market.
Also, Silver is an interesting metal in that it is 1/2 an industrial metal and 1/2 a ‘monetary metal’. Finally, it’s a very “thin” market. Not much production and wild demand swings. So it can show extremes of volatility that the other metals may not reflect as well.
So what do we see in that chart? First off, we can see the “bubble phase” near the start. Then the collapse back toward middle of the chart. Next we get a small wobbly ‘rise’ off that crash, then it ends in a very rapid collapse. Matter of a day or two. It is that speed with which silver and gold can collapse that causes me to be very early out of the metals and to avoid parabolic rise spikes (especially a late entry into them). You can lose months of “trend” in one “Gap down open”. (Or in this case, two.)
I also like this chart as we see SLV end up starting and ending at almost exactly the same places as RUT, but with a lot more volatility on the way. If you know how to trade volatility, that can make a pile of money for you. If you want an investment, it is terrible and can cause psychological trauma. Silver and metals trading are not for everyone, and silver is worst in many ways. (That “thin” market issue, and being driven by both industrial and monetary issues along with crowd dynamics).
Look at Vol+. In the bubble drop, the volume was immense. In the latest drop, not so much. Not a lot of buyers stepping up even at those plunge prices. In the parabolic rise into the first bubble, volume (black) does a parabolic too. Then the spike down has a red spike in volume to match. In the latest collapse, it’s just a bit of red spike. There was not a lot of volume build into this, it was just a normal “volume drying up” top, followed by a gap down on a load of sell orders and no buyers lined up. Look at the July / August border. Volume dries up, then prices plunge. Look at Mid August. Low volume (black) as we approach the top, then a larger red spike on the drop. Early September has slowing volume. Folks are just staying away in droves. Even in the plunge, not much really happens.
Oddly, that implies it might be a good time to buy silver. Market Makers are shoving prices down, way down, as they are buying the silver being dumped. For a trade, it’s a reasonable gamble to do a ‘friend of the market maker’ trade here. For an investment, we need to wait for some signs that a ton of silver is not still falling on us… With MACD below zero and Red On Top, it’s not time yet (on THIS time scale… a ‘day trade’ on a 10 day 15 minute chart might catch a bit of a Dead Cat Bounce for a few days). But RSI is approaching 20. That’s the “get ready to buy” marker. Now it needs to do a ‘steps higher’. THEN on the MACD crossover to ‘blue on top’ we could have a longer term “buy” moment.
But what does this price action MEAN?
It means that the industrial demand for silver has dried up (for now) and folks are sitting on inventory not wanting more. It means that “investor” demand is off as folks are still ‘smarting’ from that bubble burst and not ready to be burned twice. It means that folks without jobs don’t even buy silver jewlery as a ‘trade down’ from gold. And it means that those ads on TV didn’t rope in enough volume to keep things inflated.
How low can Silver go? In really bad times, down to about $5 an ounce. We’re at $30 now, so still downside risk.
In short, Silver is saying “not a good economy and folks are cutting back on spending of all sorts”.
Now look at stocks. The RUT is in a long down trend too. The Dow Jones DIA is only 30 stocks. A highly biased selection. QQQQ the Nasdaq is strongly biased by a high exposure to AAPL Apple Computer. The NYSE Composite has a load of overseas companies in it via ADRs (American Depository Receipts). The SPY S&P 500 is usually my favorite index to track (as it has a nice broad mix of large companies, so outperforms the ‘typical’). But to see how the broad economic picture is going, I look at the Russel 2000 RUT Index. Here we see if the “little guys” who make most of the jobs are getting better, or getting crushed.
Well, not looking so good…
The one good thing is that the last couple of months it’s not managed to crash through the 20% loss level. (If you can call that good…) From my point of view, it’s a ‘sideways roller’ and you can ‘range trade’ it (sell at the higher area, buy at the lower) but I’m not seeing anything in the way of good economic news reflected in that chart.
Now look at TLT. Long duration Treasury Bonds. Folks are flocking to ‘near no yield’ treasuries. They are scared. Now if the folks who sling $1 Billion a DAY (like the Omani investment guy who was on CNBC) are scared, well, it’s not a good sign. Only folks of that size can move bond prices. (Though the Omani guy was buying things like BAC Bank of America… but he had a bit of tremble in his voice and a sideways glance when he said it; like he was not so sure it was a bright thing to have done…)
Furthermore, The Fed has said they are going to roll $400 Billion of short duration notes into 6 year to 10 year bonds. As they do that, TLT will reach a peak (probably a bit before they are done). So while I’d NOT invest in TLT for a couple of year horizon, it ought to continue to be a ‘safe haven’ until The Fed is done and the economy looks better (like THAT is going to happen as Greece leaves the Euro Zone… I give them 3 to 6 months max to decide they would really rather have an inflating Drachma and not a German Master and tax hikes.) As soon as the trend breaks, shift to TBT (whenever the economy shows recovery and The Fed starts raising rates).
Before jumping into TLT at this point, one ought to look at a TLT Bonds chart specifically and look for things like “RSI near 80” as a warning shot… so this is a statement about the economy and NOT a specific “buy bonds now” statement, ok? Me? I’m in cash.
Now, a broad look at metals in general:
Metals a broad mix, 6 month daily chart
The main ticker here is JJC Copper. We see it dropping fairly hard. Copper is a clear indicator of economic demand by builders and manufacturers. It’s off a cliff and with a volume spike. Even worse are JJT and JJN, Tin and Nickle. About the same are Aluminum JJU and Lead LD. Not a lot of lead and aluminum in home construction. This is broader than that…
Holding up better had been the ‘semi-industrial semi-precious’ metals of Platinum and Palladium. (Folks will remember that up until about a month ago I was “hiding out in Platinum” then exited about that last ‘lower high’ point). They drop when demand for catalysts falls off. Think car catalytic converters and manufacturing of chemicals and oil products.
At the top of the chart is Gold, looking very much like a broad bubble slowly turning into a bear trend. I’ve not done a specific gold chart lately as I’m not in gold right now (and not going to be). I think you can see just from looking at it that things have not been looking good for gold for about a month now. What’s likely to happen going forward? Depends on how bad the global economy becomes, but I’d use that last silver bubble and rebound as a model (but stretched out and broadened as gold is not so thin a market and moves more slowly… most of the time.)
The simple fact is that when things start dropping, hedge funds and countries must sell gold to pay their failed bets or cover their currency manipulations. You “sell what was profitable” when you get a margin call. And folks got a lot of margin calls lately.
In Conclusion
It looks to me like metals are saying the global economy is “not so good” and precious metals are being sold to cover debts. The announcement by China that things were ‘not good’ caused a couple of days of flat out panic in the metals.
It’s time to start watching them for a confirmed bottom (then buy…) but for now, it’s still a bit early. To buy (eventually) you will need cash, so be in cash now to buy cheaper later. On a ‘trade basis’, this steep a drop is likely to have a short term bounce back up (measured in days or weeks) so traders could shift to a 10 day hourly chart for a ‘counter trend rally’ swing trade. I’m not going to do that just because it requires fast timing and I have a day job now, so can not ‘play’ mid day. That means I’m exposed to “gap opens”, and I’m just not interested in that right now.
Some live charts for your amusement and pondering:
Copper live chart
The primary industrial demand metal indicator. Whenever a recovery comes, remember “Buy More Copper!”, now not so much…
Silver Live Chart
Panic and fear can overcome any trend and the “story” never stands up to the economic cycles. But a fun ride as long as you remember to “Never ride a position down. If it moves against you, sell; THEN ask questions. -E.M.Smith” or my preferred “short form” of it: “Think IN CASH. -E.M.Smith”.
GLD Gold live chart
IMHO, early stage “failure to advance” and “first time below the SMA stack”. IFF I were the sort of person to “expect at” charts, I’d expect price to challenge about $1700 and fail, then fall away to the downside as the bear trend resolves. Then again, with the way gold in internationally manipulated, one central bank deciding to dump dollars or euros and buy gold could scratch that, so the best expectation is that gold is expensive and volatile at these levels and not worth the ‘play’.
PPLT Platinum live chart
Held up nicely until “Son Of Double Dip Panic” returned and folks started expecting a plunge of industrial demand.
Musings from the Chiefio 
E.M.
Ii’m not sure that the PM action is based on fundamentals.
What do you think of the threat of margin calls as the cause of the gold and silver drop?
Hal
From zerohedge.com
Case Closed: CME Hikes Gold, Silver, Copper Margins
Submitted by Tyler Durden on 09/23/2011 – 16:47
Copper
And there you have it: CME just hiked gold margins by 21%, silver by 16% and copper by 18%. Mystery solved.
Gold Liquidations Open Thread
Submitted by Tyler Durden on 09/23/2011 – 16:44
Eastern Europe
Update: Yep – it was a leak of a margin hike as just confirmed. Which may very well mean nobody actually had to liquidate, just the herd thundered, as it always does, in the wrong diraction. Expect gold to actually rise on this news.
Everyone knew they were coming… Just not when. Now that the gold liquidation frenzy has struck we still don’t know much if anything: who was it, why, and where did the money go? Some rumors have it as a bank in Central, Eastern Europe unwinding massive PM positions, which if true is paradoxically bullish for gold and silver as reported previously, as it means the already tight liquidity situation in Europe is about to come to a head, possibly as soon as this weekend. Others speculate it was a plain vanilla satisfaction of collateral requirements by a big funds who may or may not be liquidating and who have sizable gold positions. Or, the simplest explanation, was it simply an expectation (and leak) of a gold margin hike? For all these questions and more, as well as to vent over anything and everything, use the following open thread.
Love these bits of analysis.
@co2fan;
I’ve seen the CME raise margins and then gold skyrockets, I’ve seen them raise margins and then gold plummets, I’ve seen them raise margins 50% and nobody cared. I don’t ‘get it’. I wish someone would explain why margin hikes ‘work’ sometimes and other times make no difference.
For metals I think knowing the lead time between the initial investment and the raw material being produced would tell you what you need to know.
If, say, it takes 5 years for a chromium mine/smelter to come on line, then if someone started in 2006, the first of the metal will come onto the market now. Given that they must pay the capital investment, what ever the market price of the metal is, then you have an oversupply positive feedback loop. Suppliers MUST sell, or go bankrupt. The price will fall until enough suppliers go bankrupt for the output to equal the actual demand. Stockpiling will make the situation worse as the sale of stockpiles from bankrupt companies lengthen the time when their is an over supply and make marginals go under.
So we have steady state, drop in demand, price drop below total production cost, liquidation sales, less generation than need being balanced by stockpiles, less production than demand, economic up-turn, inability to supply market and so upward price spiral.
@co2fan:
Margin calls have a dramatic impact, but they are a secondary symptom, not a root cause. And there are two kinds of margin call…
1) The client has SOMETHING in his account that plunged, and gets a margin call. Either the client or the broker margin desk, if the client did not respond inside a couple of hours picks something to sell. It must be liquid, and usually clients get pissed if you sell something at the bottom, so the best choice is often “something with profits still in it”. Lately that has been gold.
2) The exchange raised margin requirements on the trade goods. (Which just happened, BTW). But even THAT is not primary. The exchanges raise margin requirements when they see bubblicious behaviours creeping in. It is a reaction to an overheated market, not a cause. The intent is to reduce the spike to excess (which WILL collapse) before it has run too far. Frankly, it’s a decent indicator of when to get out. When the folks who run the game say it’s way overpriced to the point of being willing to piss off their main clients, well, it’s over priced. They KNOW a fall is coming, and wish to assure that there will be enough real money in the account for them to be paid. A common market dictum is “Never meet a margin call”. I think it’s got truth in it.
So we had stocks plunging AND we had metals margin rates being raised. Yeah, that’s going to trigger a drop; but it didn’t cause the drop. The overpriced condition makes it possible to have the plunge.
So look at the charts. It’s the “odd man out” on the high side that gets spanked until back in line with the herd (that silver bubble early in the chart). The herd in general can have a positive or negative trend, that continues until conditions change. (the long term dropping upper left to lower right) and then there are the news driven events that cause ripple or daily spikes (that right edge plunge on China weakness news and margin requirements increases at the metals exchange). All can be exacerbated by a “stocks drop margin calls going out” in any given day or week, but not caused by it.
Oh, and there ARE differences inside the herd as well. So we see Tin and Nickle have downside separation from Copper. That’s because of the relative price elasticities of supply and demand curves of the metals. There is a bit of art in picking a span (starting date and ending date) for the chart to capture the essence of what is happening while seeing both “reversion to the trend mean” and “elasticity effects” on a “race” of many tickers against each other. That is why sometimes you see me put up a 1 year chart, sometimes a 6 month, sometimes a 2 year. (That, and the ability to see the individual daily price bars is a lot easier on the 6 month, so if they are the focus, I’ll go shorter too…)
Basically, Tin is more “volatile” than Copper, but shares gross economic trends. You could make a trade strategy out of their relative price actions, BTW. So if, over some modest time window, Tin is below copper, it’s a bear metals market. If Tin is above copper, it’s a bull market. When the two lines merge, it’s a trend stabilizing point (going flat or elasticity variations already priced in.) As each metal can be a bit “quirky” (i.e. Labor Strikes in Chile more likely to hit copper than nickel) it is good to make a ‘race’ of many metals so you can see ‘quirks’ like the story driven bubble in Silver against the herd
@Kevin M:
Thanks for the confirmation that it’s worth my doing… I’ve been thinking of doing more of these, then just linking back to some of them in the WSW postings. I think I could be more “timely” with the WSW ones if it had more “metals were discussed here (link) with the conclusion (foo)”. We’ll see.
My goal is to get folks to where they can see these charts and just know what they are saying. To record “how the charts speak” for others.
@Sera:
This is a bit more opinion than analysis, but… IMHO it depends on 2 things.
1) The strength of the “story”. IF for example, China was announcing stellar growth in the domestic market demand for new homes, cars, and electronic toys nobody would care about the copper margin as it would be a ‘strong story’ of exponential growth in copper demand in 1/6 or so of the global population. When you have a margin hike with China saying ‘Tepid growth at best and the 1st derivative is dropping’, well, it’s just kind of time to leave anyway so why sink more of your capital into copper margin? In essence, there is a race condition between the strength of the story and the strength of the exchange margin changes.
2) The size of margin and margin calls (how leveraged folks are). IF I’ve got my accounts leveraged at 2:1 with a 50% margin ( 100%/50% ) and the hike takes the MAX margin from 80% (5:1 or 100%/20%) down to 75% (4:1 or 100%/25%) I just don’t care. IF I’m at 50% and they take margin to 25% (4:3 or 100%/75%) I’ve suddenly got to pony up the cash to increase the amount of money in my margin reserves. That’s likely to cause me to sell something, and likely the thing being the problem…
So, $1000 of silver at 50% margin, I’ve got to have $500. Make it 25% margin and I’ve got to have $750. Easy thing to do is just sell down to $666 of gold in the account and then my $500 covers it. ( 1/4 of 666 is 166.66 and 3 x $166.66 is $500, more or less…)
So the impact depends on “How leveraged IS everybody?” and how that intersects “How strong is the ‘story’? Will they pony up more cash, or sell out the position?”.
I once got a notice from my broker that my margin account was going from 50% to something like 33% max margin. I just didn’t care as I was carrying zero stuff on margin. In contrast, the president of Chesapeake Energy held a large block of that company stock, and had margin to the max. As the market crashed in 2008 he got margin calls he could not meet, so had to sell, which drove the price down, causing more margin calls, causing more selling. He lost his entire stake to a spiral of margin calls largely driven by his own liquidations that cut the price in half and consumed his entire equity. (Later the board gave him some more, so don’t cry for him, cry for all the OTHER investors in the company who got screwed by his stupidity driving the price to crazy low prices.) You can see in those two stories how in aggregate margin changes can have little or massive impact depending on where the “center or average level of margin” is located. Near zero or near max.
The other side would be, for example, IF I just KNEW that silver was going to be THE key industrial metal due to, say, RFID tags, or IF I had a working cold fusion cell using Nickel about to hit the market… I’d mortgage the dog and sell the car to raise equity to meet margin rather than sell. The ‘strong story’ would cause the margin change to show up in other markets as I sold or margined that stuff instead and used it to fund my first love…
(You see the inverse of this too, where folks get margin calls in stocks, and sell their gold to raise equity to cover the stock margin. They may think gold has topped, so no real reason to hold it, and that stocks are cheap and they don’t want to sell them now. So a margin hike in stocks would then cause Gold to fall… Cash is fungible and that shows up in margin being somewhat fungible between markets…)
I know, lots of moving parts and strange linkages…. I hope it made some sense, though. If it didn’t, poke at the obscure bits and I’ll try again ;-)
@DocMartyn:
Nice description of the long cycle instabilities to a ‘clearing price’. Also note that some miners take active measures to dampen those effects.
One of the more ‘tricky bits’ with gold miners is that they often have several mines with different grades of ore. With gold at $350 an ounce, only the best ore was mined as it was what made money. As the prices rise, they add more of the lower grade mines. Eventually, at very high prices (like, oh, now) they are mining all the worst ore they have, that is only profitable at prices over $1000 / ounce, holding off the market and in reserve “for that day” the mine that is profitable at $200 to $300 / ounce…
This stabilizes the earnings of the miner (important when you give a press release predicting what profits will be a year hence…) and gives them control of profit and production figures. At the same time, it provides a ‘pad’ against the new miners who flood in with prices over $1500 when excess supply causes a price crash. That is why “the big boys” seem to ride out any swing, but never post those expected spectacular earnings in great price surges higher. Nice earnings, but not the astounding ones some folks expect…
In this way they mine more total ore over more years then they could if they just mined the best stuff first, so prolong the life of the company, too.
Now trying to blend those two sets of behaviours and come up with one consistent understanding… that’s the kind of stuff that drives traders mad and causes Centrally Planned Economies to tumble… A bureaucratic approach just never does capture that kind of interacting complexity of behaviour…
I ‘got it’. Had to read it it three times, but it’s starting to sink in. Thanks.
@E.M: What would you do if you were China´s treasure secretary?. There is enough room to include millions of chinese people in the market, thus most probably you would increase local market..That would devaluate the yuan a little, but there is room also in it.
“E.M.
Ii’m not sure that the PM action is based on fundamentals.
What do you think of the threat of margin calls as the cause of the gold and silver drop?”
I think metals like oil is becoming more and more controlled by the speculators. I believe you can check on gold to see how many people actually filled the contracts, but as gold and metals become more and more volatile, it will just lead to more speculators coming into the market place.