How can we explain gold dropping into the $1,300 level in less
than a week?
Here are some of the factors:
- George Soros cut his fund holdings in the biggest gold ETF (
) by 55% in the fourth quarter of 2012.
- He was not alone: the gold holdings of GLD have contracted
all year, down about 12.2% at present.
- On April 9, the FOMC minutes were leaked a day early and
revealed that some members were discussing slowing the Fed's $85
billion per month buying of Treasuries and MBS. If the money
stimulus might not last as long as thought before, the "printing"
may not cause as much dollar debasement.
- On April 10, Goldman Sachs warned that gold could go lower
and lowered its target price. It even recommended getting out of
- COT Reports showed a decrease in the bullishness of large
speculators this year (much more on this technical point
- The lackluster price movement since September 2011 fatigued
some speculators and trend followers.
- Cyprus was rumored to need to sell some 400 million euros'
worth of its gold to cover its bank bailouts. While small at only
about 350,000 ounces, there was a fear that other weak European
countries with too much debt and sizable gold holdings could be
forced into the same action. Cyprus officials have denied the
sale, so the question is still in debate, even though the market
has already moved. Doug Casey believes that if weak European
countries were forced to sell, the gold would mostly be absorbed
by China and other sovereign Asian buyers, rather than flood the
My opinion, looking at the list of items above, is that they are
not big enough by themselves to have created such a large
disruption in the gold market.
The Paper Gold Market
The paper gold market is best embodied in the futures exchanges.
The prices we see quoted all day long moving up and down are taken
from the latest trades of futures contracts. The CME (the old
Chicago Mercantile Exchange) has a large flow of orders and
provides the public with an indication of the price of gold.
The futures markets are special because very little physical
commodity is exchanged; most of the trading is between buyers
taking long positions against sellers taking short positions, with
most contracts liquidated before final settlement and delivery.
These contracts require very small amounts of margin - as little as
5% of the value of the commodity - to gain potentially large swings
in the outcome of profit or loss. Thus, futures markets appear to
be a speculator's paradise. But the statistics show just the
opposite: 90% of traders lose their shirts. The other 10% take all
the profits from the losers. More on this below.
On April 13, there were big sell orders of 400 tonnes that moved
the futures market lower. Once the futures market makes a big move
like that, stops can be triggered, causing it to move even more on
its own. It can become a panic, where markets react more to fear
Having traded in futures for over two decades, I want to provide
some detail on how these leveraged markets operate. It's important
to understand that the structure of the futures market allows
brokers to sell positions if fluctuations cause customers to exceed
their margin limits and they don't immediately deposit more money
to restore their margins. When a position goes against a trader,
brokers can demand that funds be deposited within 24 hours (or even
sooner at the broker's discretion). If the funds don't appear, the
broker can sell the position and liquidate the speculator's
account. This structure can force prices to fall more than would be
indicated by supply and demand fundamentals.
When I first signed up to trade futures, I was appalled at the
powers the broker wrote into the contract, which included them
having the power to immediately liquidate my positions at their
discretion. I was also surprised at how little screening they did
to ensure that I was good for whatever positions I put in place,
considering the high levels of leverage they allowed me. Let me
tell you that I had many cases where I was told to put up more
margin or lose my positions. Those times resulted in me selling at
the worst level because the market had gone against me.
The point of this is that once a market moves dramatically,
there are usually stops taken out, positions liquidated, margin
calls issued, and little guys like me get taken to the cleaners.
Debates rage about the structure of the futures market, but my
personal opinion is that a big hammer to the market by a
well-heeled big player can force liquidations, increase losses, and
push the momentum of the market much lower than the initial impetus
would have. Thus, after a huge impact like we saw on April 13, the
market will continue with enough momentum that a well-timed exit of
a huge set of short positions can provide profits to the
well-heeled market mover.
Moving from theory to practice, one of the most important things
to keep your eye on is the Commitment of Traders [COT] report,
which is issued every Friday. It details the long and the short
positions of three categories of traders. The first category is
called "commercials." They are dealers in the physical precious
metals - for example, gold miners. The second category is called
"non-commercials." They include hedge funds and large commercial
banks like JPMorgan. Non-commercials are sometimes called "large
speculators." The rest are the small traders, called
"non-reporting" since they are not required to identify themselves.
The ones to watch are the large speculators (non-commercials), as
they tend to move with the direction of the market. Individual
entities could be long or short, but in combination, the net
position of the group is a key indicator.
The following chart shows the price of gold as a blue line at
the top, and the next panel down shows the net position of these
large speculators as a black line. You can see that over the long
term, they move together. When the net speculative position is
above zero, this group is betting on rising gold prices. Of course,
the reverse is true when it's below zero. In this 20-year view, the
large speculators were holding net negative positions during the
lowest point of the gold price, around the year 2000. As the price
of gold rose, their positions went net long, and they profited.
(click to enlarge)
An interesting thing about the chart above is that the
increasing amount of net longs reversed itself before gold peaked
in 2011, suggesting that these large speculators became slightly
less bullish all the way back in 2010. The balance remains net
long, but it remains to be seen how long that lasts.
What is not so obvious is that these large speculators are so
big that they can affect the market as well as profit from it; when
they initiate massive positions in a bull market, they drive the
price of the futures contracts even higher. Similarly, when they
remove their positions or actually go short, they can push the
So what happened a week ago was that a massive order to sell 400
tons of gold all at once hit the market. Within minutes the price
plummeted, and over a two-day period, resulted in the largest drop
of the price for futures delivery of gold in 33 years: down $200
We don't have the name of the entity that did this. However, the
way the gold was sold all at once suggests that the goal was not to
get the best price. An investor with a position of this size should
have been smart enough to use sensible trading tactics, issuing
much smaller sell orders over a period of time. This would avoid
swamping the market; and some of the orders would be filled at
higher prices and thus generate more profit. Placing a sell order
big enough to affect the overall market price suggests that someone
with powerful backing wanted to drive the price of gold down.
Such an entity could have been a large speculator who already
had a sizable short position and could gain by unloading some of
its short position once the market momentum had driven the price
even yet lower. Or it could be a central bank - one that might be
happy to have the gold price move lower, as it would provide cover
for its printing of more new money. Of course, it could be some
entity that owned long contracts and wanted to get out of the
position all at once. We don't know, but this kind of activity,
resulting in the biggest drop in 30 years, raises more than just
suspicion when we consider how important the price of gold is to
many markets around the globe.
Can markets really be influenced by big players? Well, was the
LIBOR rate accurately reported by huge banks? Have players ever
tried to corner markets? The answer to all the above,
unfortunately, is yes.
There's an even bigger problem with the legal structure of the
futures market: even the segregated funds on deposit can be
pilfered by the broker for the brokerage's other obligations. That
is what happened to MF Global customers under Mr. Corzine. (I had
an account with a predecessor company called Man Financial - the
"MF" in the name. I also had an account with Refco, which is now
defunct. Fortunately, the daggers did not hit my account, since I
was not a holder when the catastrophes occurred.) My take: the
futures market is dangerous, and not a place for beginners.
One last note: after the Bankruptcy Act of 2005, the regulations
support the brokers, not the investors, when there are questions of
legality about losses in individual investment accounts. Casey
Research will be producing a report with much more detail on this
subject in the near future.
So, what now? We aren't going to see a secret memo - no smoking
gun to confirm that what happened on April 13 was an attempt to
affect the market. Still, the evidence is suspicious. When big
entities can gain from putting on big positions, the incentives are
big enough for them to try - LIBOR, Plunge Protection Team, Whale
, all support this view.
The Physical Gold Market
Previously, there was little difference between the physical and
paper markets for gold. Yes, there were premiums and delivery
charges, but everybody regarded the futures market as the base
quote. I believe this is changing; people don't trust the paper
market as they used to.
Instead of capitulating to fear of greater losses, the demand
for physical gold has hit new records. The US Mint sold a record
63,500 ounces - a whopping 2 tonnes - of gold on April 17 alone,
bringing the total sales for the month to 147,000 ounces; that's
more than the previous two months combined. Indian markets, which
are more oriented to physical metal, now have a premium of US$150
over the futures price in Chicago. Demand at coin dealers has
increased as the price has dropped. And premiums are much bigger
than they were as recently as a week ago.
a vendor page
that quotes purchase prices and calculates the premiums on an
ongoing basis. It shows premiums of 50% and more in many cases. On
eBay, prices for one-ounce silver coins are $33 to $35, where the
futures price is quoted as $23. A look on Friday April 19 shows
out of stock on most items:
Buy - Sell On Silver Bullion
|2013 Sealed Mint Boxes Of 1 Oz. Silver American Eagles -
Brand New Coins
||500 Coin Min.
(1 Sealed Box)
Spot + $1.80
|2013 Sealed Mint Boxes Of 1 Oz. Silver American Eagles "San
Francisco Mint" Brand New Coins
||500 Coin Min.
(1 Sealed Box)
Spot + $2.00
|90% Silver Coin Bags (Our Choice Dimes Or Quarters) $1,000
Face Value Figured at 715 Ozs Per $1,000 Face
|We Buy @
Spot + $1.70
Per Oz (Spot
+ $1.70 X 715)
|Spot + $4.99 Per Oz
(Spot + $4.99 X 715)
|90% Silver Coin Bags 50¢ Half Dollars $1,000 Face Value We
Ship in 2 $500 Face Bags
|We Buy @
Spot + $1.90
Per Oz (Spot
+ $1.90 X 715)
|90% Silver Coin Bags Walking Liberty Half Dollars $1,000
Face Value We Ship in 2 $500 Face Bags
|We Buy @
Spot + $2.10 Per Oz (Spot
+ $2.10 X 715)
|Amark 1 Oz. Silver Rounds ( Made By Sunshine ) Pure .999
||500 Coin Min.
Clearly, the physical gold market today is sending different
signals than the paper market.
The Case for Gold Is Still with Us
The long-term fundamental reasons to hold gold are undeniably
still with us. The central banks of the world are acting in concert
in "currency wars" or "the race to debase." As they print more
money, the purchasing power of each unit declines. They are caught
between the rock of having to keep interest rates low to support
their governments' huge deficits and the hard place of the
long-term effect of diluting their currency. If rates rise, even
First World governments will be forced to pay higher interest fees,
leading to loss of confidence in their ability to pay back their
debt, which will bring on a sovereign debt crisis like what we have
seen in the PIIGS or Argentina recently.
The following chart shows the rapid growth in the balance sheets
as a ratio to GDP for the three largest central banks. I've
extrapolated the expected growth into the future based on the rate
at which they propose to buy up assets. One could argue about how
long these growth rates will continue, but the incentives are all
there for all central banks to bail out their governments and their
commercial banks. I fully expect the printing game to continue to
provide the fuel for hard-asset investments like gold and silver to
increase in price in the years to come.
(click to enlarge)
Buying Opportunity or Time to Flee?
So what does it all mean? The paper price of gold crashed to
$1,325 in the wake of this huge trade. It is now hovering around
$1,400. My first reaction is to suggest that this is only an
aberration, and that the fundamentals of the depreciating value of
paper currencies will eventually take the price of gold much
higher, making it a buying opportunity. But what I can't predict is
whether big players might again deliver short-term downturns to the
market. The momentum in the futures market can make swings
surprisingly larger than the fundamentals of currency valuation
Traders will be looking for a significant turnaround to the
upside in price before entering long positions. However, a
long-term, fundamentals-based trader has to look at the low price
as a buying opportunity. I can't prove it, but I think the
fundamentals will drive the long-term market more than these
short-term events. The fight between pricing from the physical
market for bullion and that from the "paper market" of futures is
showing signs of discrimination and disagreement, as the physical
market is booming, while prices set by futures are seemingly
pressured to go nowhere.
In short, I think this is a strong buying opportunity.
I have no positions in any stocks mentioned, and no plans to
initiate any positions within the next 72 hours. I wrote this
article myself, and it expresses my own opinions. I am not
receiving compensation for it. I have no business relationship with
any company whose stock is mentioned in this article.
A Failure To Act: Fed Policy And Interest Rates