Dark Pools, Program Trading and the Price of Gold

(This report first published and posted on May 15, 2013 — but is even more timely today!)  

Day after day, gold trading has been, and continues to be, dominated by institutional trading in the “dark pools” where over-the-counter dealer and interbank activity goes largely unseen.

Don’t under-estimate the influence of trading in the dark pools where “invisible” institutional trading can – in a flash – knock gold to the mat, leaving most gold-market participants and observers wondering what happened.

Indeed, much of this activity in the interbank and dealer market goes unreported – but buy-sell transactions, high-frequency, and other program trading in these dark pools, often at crucial chart points, can be overwhelming — sometimes triggering bigger waves of buying or selling –with big profits for those institutional trading desks that know how to play the game.

The gold market is especially vulnerable to trading in the dark pools because it offers a relatively small playing field compared to equity, bond, and currency markets – and the flow of funds, in or out, can have a larger price effect.

With gold markets sometimes overwhelmed by trading in these dark pools of low-cost liquidity (thanks to the Fed’s near-zero interest rate policies) the near-term outlook for gold remains highly uncertain.

That said, the long-term fundamentals and physical-market developments are more bullish than ever – or at least more bullish than we’ve seen in many years – and sooner or later these must rule the day.

Gold continues to confound as technical and computer-driven program trading triggers selling on U.S. derivative markets – all despite favorable physical-market fundamentals and what should be seen as economic and geopolitical developments favorable to gold.

The underlying gold-market theme in recent days, weeks, and months has been, and continues to be, selling of paper gold derivatives on futures exchanges and, importantly, over-the-counter dealer and interbank markets (the so-called dark pools of liquidity).

Much of this undercover paper activity is made possible by the Fed’s near-zero interest rate policy. The dealers and traders that comprise these dark pools are profitable, at least in part, because their cost of money is so low and the availability of liquidity is seemingly unlimited.

Indeed, this machine-driven trading activity — and the abandonment of long positions seeking higher yields — explains the paradoxical failure of gold to move higher . . . as one would expect during a period of super-accommodative, highly reflationary, monetary policies now being pursued by the Fed and other major central banks around the world.

If this were a sic-fi movie it might be titled “Invasion of the Machines.” And, just like the movies, the good guys — those with patience who have trusted the long side — will win in the end.


Gold-Price Weakness: More March Madness?

Frankly, I’ve been surprised by the recent decline in the price of gold.  I expected a stronger finish to the first quarter with gold prices somewhat higher – possibly even breaking out above the $1,400 an ounce level by the end of March.

Instead, gold prices have softened considerably over the past couple of weeks – off nearly $100 an ounce from its mid-March highs and down three percent in just the past week.  On a more positive note, gold is still up 7.5 percent for the year to date.

With gold now hovering around the 200-day moving average and short-term momentum now moving into negative territory, the technical picture has been damaged – and, barring some sudden reversal to the upside, the possibility that short-term traders will force the price lower is increasing. 

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A Quick Note on Gold Price Prospects

We are advising clients and subscribers to NicholsOnGold to expect another up-week for gold . . . driven largely by geopolitical anxiety over the conflict between Russia and Ukraine and the likely outcome of Sunday’s referendum on the future of Crimea.

Gold is once again performing its historical function as a hedge and insurance policy against geopolitical risks and the vulnerability of other asset classes including equities and bonds.  Gold is also performing well vis-a-vis the dollar and most other currencies.  

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The Russian Bear – Bullish for Gold

So far, the gold market has largely ignored the East-West clash over Ukraine and control of Crimea. With gold recently trading mostly within the $1,340–to-$1,350 range, we’d guess the Ukraine/Crimea crisis has added no more than $10 or $15 an ounce to the yellow metal’s price.  But there is the potential for larger, more dramatic price movement in the weeks ahead.

For the next few days, world financial markets will be anticipating the March 16th referendum in which Crimea will likely vote to secede from Ukraine and join the Russian Federation.  While this may already be reflected in the price of gold, what comes after – in the form of Western sanctions and Russian reactions – has not yet been accounted for in the metal’s price.   

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Russia Drives Gold

Russian saber-rattling sent gold over $1,350 an ounce earlier this week, its highest price in four months.  But, contrary to many press reports, it was neither safe-haven demand nor physical buying that fueled gold’s short-lived price advance.

Instead, it was institutional speculators and short-term traders – among them the trading desks at some of the gold-dealing banks – who rushed reflexively to buy gold futures and other “paper gold” derivatives . . . and then sold quickly to take profits as the crisis seemed to abate. 

Meanwhile, buyers in China and India, the two largest physical markets in the world, continued to dance to their own market fundamentals, virtually ignoring the geopolitical drama unfolding in Europe.

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Easy Money – The Elixir of Gold

So far, 2014 has been a year of recovery for gold.  Trading recently near $1,320 an ounce, the metal is already up some 10 percent from its 2013 year-end price of $1,201.50 in the London bullion market.

Gold’s improvement was apparently quite a surprise to many of the most prominent analysts and investors who, forecasting the price through a rear-view mirror, expected prices to head further south.  With gold possibly on a sustainable upswing, they are now busy jacking up their gold-price targets.

Although gold has recovered smartly in recent weeks, an uninterrupted upswing to progressively higher levels is hardly assured.  Indeed, the yellow metal may have a steep uphill fight, very likely with occasional setbacks that are mistakenly taken as signs of further weakness and deeper setbacks ahead.  

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Gold Mine Production: Who Cares?

Gold-mine output and production costs may mean a lot to gold miners and to investors in gold-mining equities, but should they mean a lot to the rest of us?

Total global gold-mine output (primary supply) will make headlines this year, hitting a new record with “reported” annual production just over 3000 tons (about 96.5 million ounces).

Actual mine production is probably somewhat higher taking into account unreported output from informal producers and under-reporting by China and possibly a few other countries.

The continuing growth in worldwide mine production – even in the past year of low prevailing prices – is in contrast to the expectations of many investors and analysts who have been counting on declining gold production to set a floor under the price and set the stage for the next leg up in a long-term bull market.  

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India Gold: Hot Curry on this Year’s Menu

In this “NicholsOnGold” commentary, we take a look at the gold-market situation and outlook for India, long the world’s biggest gold-importing country.

The precipitous fall in gold imports during 2013 – from an annual rate of roughly 1000 tons per month early in the year to an annual rate of only 250 to 300 tons late in the year – was a powerful negative influence on the metal’s price in world markets during the past year, its impact on price being both physical (in terms of the overall global supply/demand situation) and psychological (in terms of investor sentiment).

A relaxation of these policies, possibly ahead of the country’s general election this May, could prove to be a big plus for gold in the year ahead.

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China’s Central Bank Buys Gold on the Sly

Bullish news may soon be coming out of China.  We hear that the country’s central bank will soon announce a substantial increase in its official gold holdings, bringing the total to some 2,710 tons at the end of last year.

NicholsOnGold has long held the view that China’s central bank, the People’s Bank of China (the PBOC), has been surreptitiously adding to its official gold reserves.

The PBOC reported in April 2009 that its official gold reserves stood at 1,054 tons – and it has not reported any increase in official gold reserves since that announcement nearly five years ago.

Now, it seems, we will soon learn it bought a total of 654 tons in 2009 through 2011, another 388 tons in 2012, and more than 622 tons last year.  Much of this has come from domestic mine production and secondary supply.

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Gold, ETFs, the Fed, and Equity Valuations

Over the past year or two, as the broad equity indexes moved from one high to the next, institutional money – seeking higher quarterly returns – has been moving out of gold and into stocks.

This institutional flight from gold by Western investors may have been the single-most important factor weighing on gold prices in the past couple of years – and it owes much to the introduction and popular acceptance of gold exchange-traded funds over the past decade.

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