ROSS NORMAN : Gold – The derivatives tail wagging the golden dog ?
This is how my morning went...
Journalist : “So, if gold is at an all time high again, can you suggest some people we can interview about why they are driving this market higher – or maybe a place we can go to get a picture of people queuing to buy bullion ?”
Ross : “No”
Journalist “Why not ?”
Ross : “There aren't any.”
Journalist : “Right … so this bull run is devoid of any participation ?”
Ross : “... largely, yes”
This is a most peculiar bull run. And even harder to explain.
For some looking to explain the move, it is a chance to air their pet grievance or concern … secret government buying, bank short-covering … Chinese buying … only to be dis-abused by the data.
I would maintain that after a significant amount of new year Chinese physical gold offtake – retail, jewellery, institutional and official … the Chinese specs stuck their oar in, buying on exchange and OTC forwards, futures and options. And they bought in massive size, confident that they were swimming with the tide … 2 possible arguments in their favour – either the Fed would have to cut rates or crash the economy … so it was a question of “when” and not “if” … and rate cutting cycles predictably presage double digit gains in gold … or it was simply down to domestic Chinese economic issues … and no coincidence gold is again reaching a head just as the Chinese economy crashes … chose your poison – it matters little.
The idea that the market is derivatives lead makes sense in many ways … why else would gold rally to an all time high just as inflation falls and quickly, as the dollar gains, treasury yields gain etc … all normally surefire leading indicators of the opposite ? And that's the thing about a derivatives position … they can be largely agnostic of market signals. Buy enough gold calls though and gold will rise on the delta hedging … and then do it so big … that a rally becomes a self-fulfilling prophecy.
Meanwhile, Indian demand has waned after the sugar-rush from the duty cut rally and domestic prices, as in Shanghai, now trade at a large discount to the loco London or international price. Traditional physical buyers are just not buying in. Middle Eastern gold buyers are going for lighter and lower caratage gold jewellery, while Chinese and Hong Kong jewellery groups report a significant decline in trade, etc etc. The market has lost its connection to its base.
In the US and Europe it is worse.
Physical dealers in Germany – often second only to China in size on gold coins and bars – the physical trade has been worringly thin. Only the UK stands out as an exception where the poor old inhabitants have been frightened to near death by threats of massive tax increases by its new government, prompting a flight to safety. But the UK is a small market.
But there has been a second phase to the Chinese specs – and that is the US specs … they have joined the party late … twas was ever thus … with futures longs now at a near 4 year high. For sure the institutional buyer has also re-emerged and the net ETF position has turned net positive probably driven by momentum plays as much as anything else (gold does well when it gets headlines – another self-reinforcing story).
So where does this leave us … ?
A market which is largely unswayed by normal drivers … (its 6 month correlation co-efficiency with the dollar is -0.25 while with treasury yields it is +0.7), technically overbought, and whose fundamentals suggest it is well above fair value … that said, derivates by their nature often have a long leg towards expiry and as such, no immediate price correction is in prospect. That's a long way around in saying that even though I don't believe this rally … I would certainly not short it … and gold will almost certainly go higher and I would not be surprised to see $3000 this side of Christmas.
Ross Norman
CEO
www.MetalsDaily.com