Friday, July 12, 2013

Gold market looks forward to a far better tone

By Alasdair Macleod

This week bullion prices began to rise in quiet conditions, with gold rising more than 6% and silver by slightly more. Trading patterns have changed, with much of the rise coming during U.S. trading hours, confirming that the short positions on Comex are being squeezed.

These shorts are at record levels, as shown in the chart below of Managed Money shorts.

And it is not just Managed Money: The Swaps are now nearly in balance, as are ”Other Reported Positions” (i.e. large speculators) courtesy of their near-record shorts . And as we know, the bullion banks are now prepared for a price rise, having gone net long. But the most interesting development this week is Gold Forward rates (GOFO) turned negative.

When GOFO goes negative it indicates that the cost of leasing gold is greater than Libor. The normal condition is for gold leasing rates to be less than dollar Libor, giving a positive GOFO figure. Admittedly, one could argue that with Libor reflecting the Fed’s zero interest rate policy this is no big deal. However, it does reflect a shortage of gold liquidity.

We have to consider this in context. I have managed to establish beyond doubt that central banks have been supplying the market with physical gold for the price to remain near current levels in the face of high global physical demand. The link to the relevant article is here. Therefore, GOFO turning negative is a sign that central banks are at least reducing the pace of their gold leasing, and might even be withdrawing from the market altogether.

It is against this background we need to also consider the very low levels of liquidity indicated by the dealers’ bullion held in Comex-registered vaults, which has fallen to less than 31 tonnes (representing settlement for only 10,000 contracts).  Interestingly, few days pass without an exchange-for-physical settlement in the active August contract, totaling 45,305 contracts this week alone. Furthermore, not all of the expired May contract appear to have been settled.

Therefore we must conclude that liquidity in both physical and paper markets from all sources has dried up.

The lack of supply, including liquidity provided by central bank leasing, tells us gold is simply priced at the wrong level, and needs to adjust upwards at least to the $1,550-$1,575 level established before the market was driven lower in early April.

A move of this magnitude is completely unexpected in the market, except perhaps by the bullion banks that have transferred their shorts to hapless hedge fund managers, reflected in the chart above. But this is what bear squeezes are all about: The last seller has sold, the stock has disappeared and there is none now available. Prices in these conditions usually rise very rapidly.

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