Selling Both the Rumor and the News Turns Out Not to Work …

In our interim update on gold a few days ago we wrote:

 

“It seems possible that news of a budget and/or debt ceiling deal could send gold prices even lower, but the likelihood of that happening is actually not as pronounced as it would have been if prices had risen during the current period of uncertainty.

Usually either the rumor is bought and the news are sold, or vice versa. Cases of 'sell the rumor and then sell the news as well' are generally fairly rare.”

 

It should be remembered in this context that gold was supposed to follow a certain script in the context of the debt ceiling debate, written by Goldman Sachs analyst Jeffrey Currie and given the placet of analysts at virtually every mainstream bank:

 

“Once we get past this stalemate in Washington, precious metals are a slam dunk sell at that point,” Currie said. “You have to argue that with significant recovery in the U.S., tapering of QE should put downward pressure on gold prices.”

 

The markets rarely make things that easy, although one must of course keep in mind that the action over a few trading days cannot yet be called conclusive with regard to the medium term trend. In this particular case, shorts thought they had received an invitation to shoot fish in a barrel, but the market evidently decided otherwise.

 


 

Dec gold dailyGold, December contract daily – following a false breakdown, the contract shot higher upon the budget deal resolution – click to enlarge.

 


 

As the above chart shows, while the especially smart bears who thought they could break gold below short term support by selling over $600 million notional  on GLOBEX prior to regular COMEX trading hours had their clock cleaned, the bulls cannot yet claim a decisive victory either. Still, they have won an important battle. Here is a close-up of the action:

 


 

Dec Gold 30 min chartDecember gold, 30 minute chart – click to enlarge.

 


 

The biggest positive is in our view the 'false break' highlighted above. Selling thousands of contracts in the 'off hours' has this time not been enough to actually break support. When a market isn't going down when it 'should', it often goes up instead. This is an excellent example for this rule.  However, bullish traders require some follow-through buying at this juncture to produce a decisive trend change. There is strong lateral resistance in the 1340-1350 area, and it needs to be overcome to pronounce the trend truly changed.

Interestingly, as can be seen in the chart of 1 month GOFO (gold forward rate) by Societe Generale below, the gold forward rate has once again turned into negative territory in the London market. While this is not quite as significant as some people have asserted in light of extremely low LIBOR rates, it is still remarkable – moreover, negative GOFO rates always tend to provoke rallies in the gold price in the short term. There simply are no exceptions to this rule we know of. 

Normally, gold is lent out in order to obtain collateralized dollar loans at a very low interest rate, as the lease rate paid on gold is deducted from LIBOR in these transactions. The situation actually reverses when GOFO is negative, as then whoever is on the other side of the trade actually pays for obtaining the temporary use of gold. Why would anyone want to do that?

We believe the answer has to do with the fractionally reserved gold system involving unallocated gold accounts (i.e., irregular gold deposits). According to what must be considered quite credible estimates, the leverage employed can be as high as 100:1 – which is to say that unallocated gold accounts are backed by only a single ounce of gold per 100 ounces deposited. 

The remainder of the deposits has been employed by bullion banks for their own business purposes – it is essentially fractional reserve banking, only it is using gold as the underlying currency. So what happens when delivery demands or demands to move gold from unallocated to allocated accounts exceed the amount of physical gold actually at hand? One way to satisfy such delivery demands in the short term is to borrow gold. So we suspect – although we cannot prove it – that this is why GOFO has turned negative.

 


 

SG GOFO squeeze_01 month GOFO turns into negative territory again – click to enlarge.

 


 

We also like that Thursday's rally was greeted with incredulity all around. A friend sent us the following smattering of quotes from the mainstream financial press. We especially like the guys who just know that the 'gold bull market is definitely over':

 

“The markets had anticipated a last-minute compromise of this kind," says a note from German investment bank and bullion dealers Commerzbank. "What is more, this also means that the scaling back of Fed bond purchases will be further postponed. A renewed sell-off of precious metals thus failed to materialize."

Issued before the debt-limit fix, "Resistance lies between 1301 and 1307," said Scotiabank's technical analysis Wednesday night, pointing to gold's 50% retracement of both its 2008-2011 uptrend and this year's June-August rally.

Longer-term, however, "Desire to buy gold as a hedge against the consequences of monetary policy has diminished," reckons Credit Suisse analyst Tom Kendall, who in February announced the "beginning of the end of the era of gold".

"When you've got other asset classes, equities in particular, doing so well, then it's hard to divert investments out of them and into something like gold, which is falling."

"A lot of gold," agrees Robin Bhar at Societe Generale, also speaking to Bloomberg today, "has been held for speculative purposes, investment and a store of value, and that's less of a reason going forward.

"If you sell your gold and put your money into equities, other fixed-income assets or real estate, you're going to show a return. The gold bull market is definitely over."

But "although the US has managed to avert a default," counters Nic Brown's commodity team at French investment and bullion bank Natixis, "[it] has clearly lost some credibility" with foreign creditors led by China. Not only did Washington's behavior annoy T-bond holders, says Natixis, "a concrete long term solution has once again failed to emerge."

 

(emphasis added)

And so it goes – we are going to keep these quotes for reminiscence purposes.

 

Gold Stocks

Yesterday the HUI gapped up above its 20-day moving average. We have become a bit wary of such gaps, but want to point out that the action so far looks quite similar to what happened in early July. Even today's pullback is reminiscent of the action following the gap up in July.

Whether the similarities will continue we cannot say, but we do like the fact that the index has done what it was expected to do in view of the wedge-like decline that preceded the recent rally.

 


 

H+ÖI-dailyHUI daily – now we have an MACD buy signal as well, tentative though it may be – click to enlarge.

 


 

Also worth noting is that in spite of gold's very strong rally, the HUI-gold ratio continued to improve somewhat:

 


 

HUI-gold ratio

HUI-gold ratio still improving – and the recent move to new lows is beginning to look like a false breakdown as well – click to enlarge.

 


 

So here we have another 'false breakdown' in terms of the ratio of gold stocks to gold and obviously it would be quite encouraging if it manages to hold up.

 

Conclusion:

As before, we cannot yet say whether a trend change is definitely in the bag. However, considering how absolutely dismal sentiment on gold is, considering the many similarities to the 2008 'retest' that could be observed recently (back then, gold was also declared 'dead' by the mainstream) and given the fact that for a change, the gold market has not acted in the way that was widely expected, it continues to make sense to look for more signs of a trend change to emerge.

Ideally declines should continue to be kept in check by support at $1275, while any rally that manages to exceed the $1350 level on a closing basis and confirmed by the gold stock indexes can probably be interpreted as a sign that the short to medium term trend has finally reversed for good.

 

 

Charts by BarCharts, StockCharts, Société Générale


 

 

 

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18 Responses to “Gold Fails to Obey Script”

  • Mr Sunshine:

    Thanks for all the comments, am finding the whole discussion very interesting. Seems a lot of opinion split on this across the blogasphere.

    Dan has an opinion here that it is the hedgies that are selling and bullion banks that are buying.

    http://traderdannorcini.blogspot.ie/2013/10/no-follow-through-for-gold.html

  • Mr Sunshine:

    Hi,

    New to this blog but loving it – so many thanks for your efforts.

    Can anyone tell me what is to stop these massive bear raids from reoccurring? As gold investor I have been struggling to figure out

    1. Where is fuel for their scale coming?
    2. Can’t these people keep on doing this indefinitely?

    Thanks

    • worldend666:

      Hi Mr Sunshine

      There are quite a few obstacles to doing it indefinitely. The main one is the amount of gold remaining in the GLD ETF. Gold gets drained from GLD during price drops by the bullion banks supposedly (until now a conspiracy theory) to make good on their promises of physical delivery on the Comex and the LMBA. About 1/3 is already gone since the beginning of the year, so obviously that will come to an end at some point.

      Another obstacle is demand for paper gold. After the bullion banks crash the price by dumping naked short positions onto the market they will need to close them out. If the price of gold is lower when they close out, it’s fine for them but at some point when gold represents excellent value, big players will take the other side of the trade and the shorts will get burned.

      The demand for physical gold is also important. When a futures short position is created the seller agrees to deliver physical gold on a fixed date in the future. Most of the time the party taking the opposite side of the trade takes delivery in cash, but when the market frets that the bullion banks will not have enough gold to deliver traders are more likely to ask for delivery in physical gold. At some point commentators expect the bullion banks to get caught with their pants down and no gold to deliver. On that day the price of physical gold and paper gold will go their separate ways.

      • RedQueenRace:

        I disagree that this is happening but would be willing to carefully consider any argument that shows how this “draining” is done.

        Gold moves in and out of the ETF when it fails to track the underlying properly. In order for gold to drain from the ETF the shares must be underpriced relative to physical gold. This causes APs (Authorized Participants) who act as arbs to buy the ETF shares and short gold, locking in a profit on the price difference. The shares are then redeemed, draining gold from the ETF. The gold is then used to cover the short. This process works in reverse when the shares become overpriced relative to the underlying assets.

        Note the problem here. The arbs are BUYING underpriced GLD shares. But in order for them to be underpriced some type of unbalanced SELLING had to take place. Assigning both sides of this to the arbs (which could be a bullion bank) makes no sense. A scenario could always be concocted where a BB benefits using this mechanism and multiple actors, but it is probably going to get pretty complex and difficult to support.

        It is also possible to simply redeem shares to obtain gold, though it can only be done by an AP and in quantities that are pretty much beyond the capability of a non-institutional ETF holder. But that is not a nefarious action as those shares are a claim on that gold and presumably the shares were acquired in the open market or by previously depositing gold with the ETF. The amount of gold the ETF holds is directly proportional to its share count. This does not have to have any particular relationship to the gold price.

        This process is known as creation/redemption and it applies to other ETFS, not just GLD. It is explained in various places, not always very well, but one of the best I have seen is at Kid Dynamite’s World (blog of a former investment bank trader).

        • RedQueenRace:

          Since I mentioned Kid Dynamite I also would like to point an article of his to Pater, given the recent mentions of the big overnight selling.

          http://kiddynamitesworld.com/concrete-evidence-gold-manipulation/

          It discusses how heavy buying came into gold during the low-volume overnight hours in a very short time frame.

          • jimmyjames:

            It discusses how heavy buying came into gold during the low-volume overnight hours in a very short time frame.

            Buying “and” selling- you cannot have one without the other.. ever…did you read this blog post or not?

            The fact is that… that sort of massive trading long/short took place during low volume trading has suspicion directed towards it.. someone.. something- had no trading discipline…yes/no?

            RQR- you cannot have more buying than selling or vise versa-
            Sentiment baby- that’s all it ever is….or rather was- nothing is cut and dried these days-
            Dis gold all you want.. you might find yourself wanting-

            • RedQueenRace:

              Huh?

              Did you read and understand the point of the link?

              There have been multiple posts here about how gold got knocked down during low liquidity hours. A certain segment in the gold community hollers every time this happens. Kid Dynamite pointed out that the EXACT SAME THING happened to the upside but of course there were crickets when this happened versus the ranting that goes on when it is to the downside. This wasn’t about whether actual manipulation was taking place or not. It was about being consistent in both directions. Understand the point before you start criticizing.

              I own gold and the miners and happen to be a fan of the metals. Don’t assume you know me.

              • worldend666:

                I read the article. I have wondered this myself. The conclusion I came to was that there is indeed manipulation but not necessarily only to the downside. More than likely they are just fleecing (triggering margin calls for) over-leveraged gamblers by swinging the price in both directions.

              • jimmyjames:

                RQR- I was responding to the KD link you posted-

                *******

                Yet somehow I doubt we’ll see the precious metals patriots telling it like it is and complaining about today’s vertical price action in illiquid hours. Nope – that wouldn’t fit their campaign of misinformation designed to deceive their readers into buying gold and silver*.

                So remember the absurdity of declaring that when you see a chart like this, it’s manipulation:

                ***************

                Why is it absurd to believe there was manipulation- in both directions- considering the volume that was traded during a normally low volume electronic trading market?

                I agree that there shouldn’t be noise made only when the price drops and not when it favors your position- manipulation should be investigated in both instances- so I hope he does e-mail the CFTC

        • worldend666:

          Thanks for the detailed explanation of the inner workings of GLD. I was aware of that. In fact there is a nice explanation also to be found on Adam Hamilton’s site about how GLD works and also a debunking of many of the conspiracy theories here: http://www.zealllc.com/2009/gldcons.htm

          I don’t really have an opinion on whether it’s happening or not. I don’t know, but empirically it’s quite normal for ETFs so become undervalued relative to the underlying asset during bearish phases, and authorized participants could benefit significantly from this anomaly should it persist.

  • No6:

    Maybe, putting the slam-dunks and COMEX deposits together, what we are seeing is tight physical supply necessitating bear raids on GLD.

  • Calculus:

    Classic market perversity wasn’t it?

    80% of the long term bulls were expecting further weakness and a good ol’ smash when the debt impasse was sorted.

    100% of the bears were obvioulsy expecting lower prices and a good ol’ smash.

    Probably 80%+ of innocent bystanders where also expecting further price declines.

    Add them all together and you have 90% of market participants expecting not only lower prices but a $20-$40 smash in about 5 minutes worth of trading (we all know how it goes).

    So what does Gold do, it launches like a Saturn rocket, nearly $50 higher. And not only that, perversity was hard at work again making it very hard to buy as the move too about 20 minutes.

    So now we know how to make ‘easy’ money. Find markets where the consensus is so one way, then go the other. Ha, I wish it was that easy because next time something like this sets up (in any market) and you go long, chances are 1 of 2 things will happen –

    1) The boys will smash it a touch, preferably through some important low and THEN bid it to the moon with you stopped out and not onboard, or

    2) The consensus this time will be correct and they’ll smash it stopping you out.

    Perversity sadly dogs every trader and investor every day of their trading/investing life….

  • jimmyjames:

    The remainder of the deposits has been employed by bullion banks for their own business purposes – it is essentially fractional reserve banking, only it is using gold as the underlying currency. So what happens when delivery demands or demands to move gold from unallocated to allocated accounts exceed the amount of physical gold actually at hand?

    ***********

    Basking on some Mediterranean beach with a hot and bought young chick… John Corzine… has the formula for that minor irritant-

  • No6:

    Must have come as a bit of a surprise as JPM had to make a large deposit to COMEX storage.

  • JE Stater:

    Nice. I got my hands on some around 1270. Somewhere you need to start building your position, might still be too early, but who can tell.

    • jimmyjames:

      might still be too early, but who can tell.

      ***********

      Exactly- no one can pick the exact bottom unless by luck- but when you take a broad view of the complete monetary shit show that we have to cringe through.. on a daily basis.. imo… looking fundamentally as a contrarian- the bottom has already happened or it will be there shortly-
      I’ve bought every bottom (minors) since July/2012- so take my words with a grain of salt-

      • jimmyjames:

        btw… AM…I’m trying to make a donation and even though I list my country as Canada- they demand a county and the only counties that are available are from England.. and I cannot get by that glitch-

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