Gold market report: a far better tone to precious metal markets

Jul 12, 2013·Alasdair Macleod

This week bullion prices began to rise in quiet conditions, with gold rising over 6% and silver by slightly more. Trading patterns have changed, with much of the rise coming during US 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.

Managed Money short position

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, totalling 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 which 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.

Next week

Some major statistical releases next week, as detailed below.

Monday: China Industrial Production, GDP, Retail Sales. US Empire State Survey, Retail Sales and Business Inventories.
Tuesday: UK CPI, Output Prices. Eurozone HICP (final), Trade Balance, ZEW Economic Sentiment. US CPI, Capacity Utilisation, Industrial Production.
Wednesday: UK Average Earnings, BoE MPC minutes, Unemployment Rate. US Building Permits and Housing Starts.
Thursday: eurozone Current Account. UK Retail Sales. US Initial Claims, Leading Indicator, Philadelphia Fed Survey.
Friday: UK Public Sector Borrowing.

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