Market Report: Good start to September

Sep 9, 2016·Alasdair Macleod
MR Sept9 1

The end of August saw an options expiry plus a month-end, both factors leading to lower prices.

But despite the Labor Day holiday on Monday, which kept trade quiet this week, precious metal prices rose strongly, before some consolidation set in on Wednesday. Gold had risen from $1310 the previous Friday to a high of $1352, before drifting off to $1336 in early European trade this morning. Silver bottomed at $18.75, and rallied to $20.13 before drifting off to $19.52 on the same time-scale.

Pundits with little else to say tell us that September is traditionally a good month for gold. Nice to hear, but as they say, past performance is no guide for the future. But with August’s dog days behind us and the holiday season as well, investors are likely to give market valuations more attention. The rally in precious metal prices this week was entirely logical, as was some profit-taking in the second half.

What continues to confound many observers is the over-bought condition on Comex, defined by the net longs in the managed money category. This is shown in the next chart.

MR Sept9 2

The managed money category holds record long territory, greater than at the speculative peak in the gold price in September 2011. Furthermore, the switch from negative sentiment from last December is the most remarkable flip in the history of the chart. The strain this switch in sentiment implies is reflected in the swap positions, shown next.

MR Sept9 3

The chart, which is of the last two years only, shows how the swaps have been unable to close down their net short positions by much, from the all-time record level of early-July. It also shows a close correlation with the gold price, which is actually what should happen.

A little explanation is needed. The role of a swap is to hedge positions, taken out elsewhere, perhaps reflecting options or over-the-counter (OTC) commitments. However, increasingly swaps appear to have reflected the net positions of bullion banks’ trading books, and become the counterpart of speculative hedge fund bets. Hence the almost perfect negative correlation between the two categories.

That correlation persists to this day, and one way or another, the extreme positions both categories reflect today will end in tears. The question is, will the managed money category overwhelm the swaps, or will the swaps prevail yet again? There is some anecdotal evidence that less speculative funds are using Comex to build their exposure to gold, having had no exposure to the best performing asset class so far this year. Therefore, there is good reason to expect the squeeze on the swaps to continue, forcing them as a class to abandon their short bets.

They have been helped somewhat by evidence of increased hedging by the miners. But negative interest rates, and the failure of unprecedented global monetary expansion to improve the economic outlook, is an enormous incentive for western investors to continue to buy gold.

This is why September might matter. Traditionally, this is the time of year when Asian wholesale demand begins to pick up. If this conflicts with increasing demand from underweight western investors, it could be fireworks, or even a bonfire, for the swaps.

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