Archive for ETFs

GOLD — Confounded by the Machines and Dark Pools

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(Posted: May 7, 2013)

Gold continues to confound, dropping another $25 an ounce this morning as technical and computer-driven program trading triggers selling on U.S. derivative markets, all despite favorable fundamentals and what should be seen as favorable economic and geopolitical developments.

Gold Lower Despite Bullish News

This morning’s dispatches from India and China, the two biggest gold-consuming nations, report that demand in these markets continues unabated . . . and coin dealers report still-strong retail demand for bullion coins and small bars in the Western markets.

News from the Middle East — Israel’s air strikes on Syrian targets and the rising potential for an escalating conflagration — in days of yore would have been sufficient to send gold prices skyward.

Meanwhile, this morning’s news from the Australian central bank that it was cutting its key policy rate to a record low, following last week’s rate cut by the ECB, and Fed Chairman Bernanke announcement that America’s central bank stands ready to step up its monthly bond purchases if the economic environment remains questionable — these monetary-policy moves taken together along with similar easing by other central banks — suggest the global economy may be entering a “competitive devaluation” “beggar thy neighbor” competition in which the only real winner will be gold.

The underlying gold-market theme in recent days, weeks, and months has been and continues to be selling of paper gold derivatives, including gold ETFs and futures, and over-the-counter dealer and interbank trading in Western markets and, all the while, strong physical demand for bullion products and investment-grade jewelry mostly in Eastern markets.

The Paradox Explained

Importantly, much of the activity in dealer and interbank trading goes unreported — with selling and “high-frequency trading” by the “dark pools” of liquidity at crucial chart points in order to trigger and profit from the bigger waves of selling that follow.

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

Indeed, this machine-driven trading activity at least partly explains the paradoxical failure of gold to move higher — as should be expected during a period of super-accommodative, highly reflationary, monetary policies pursued by the Fed and other major central banks around the world.

While some of this low-cost liquidity is funding the “bubble” on Wall Street, along with some small recovery in the U.S. housing market, and even strong physical gold demand around the world, it is also funding this dark pool trading activity that has been pressuring gold to incrementally lower price levels.

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.

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QUICK MARKET COMMENTARY

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(Posted: April 24, 2013)

Despite further gold ETF liquidation in recent days and some short spec selling on futures exchanges, gold prices are moving higher on unrelenting physical demand for small bars, coins, and jewelry from the gold-friendly Asian markets as well as retail investment demand in US and European, especially for gold (and silver) bullion coins.

It is particularly encouraging to see gold move higher despite the stronger dollar (against the euro and yen, for example) . . . and at a time when equities are moving lower (or at least are not moving higher).

In the past year and a half, the continuing advance of world equity markets has attracted investor and safe-haven funds that might otherwise have gone for the gold. Now, it looks like the appeal of equities is diminishing with the yellow metal being a significant beneficiary.

Short liquidation by bearish speculators and traders is likely now diminishing as momentum indicators become more encouraging and some traders begin to take profits.

Reports that major mints having difficulty meeting market demand for bullion coins are simply encouraging buyers despite higher retail premiums.

Today’s weaker than expected U.S. durable goods data — and shifting expectations among some investors and traders of easier than previously expected Federal Reserve monetary policy later this year and next — may be discouraging shorts and encouraging longs in paper gold markets.

While near-term prospects remain uncertain, medium- to long-term performance could surprise investors and speculators alike.

As we’ve stated over and over again, much of the gold now purchased in physical markets around the world is going into “strong hands” — that is to say by long-term investors, many of whom will hold gold indefinitely, and by central banks, some of whom are accumulating bullion as a legacy for future generation as a reserve diversifier, alternative to the dollar and euro, or (as with China and Russia) to achieve their global monetary and economic ambitions.

Importantly, the “stickiness” of demand is creating a shortage of available physical gold — what I call “free float”, the result of which may very well be greater-than-expected future price increases once the market turns convincingly higher.  More simply, available supply will be insufficient to satisfy demand except at much higher price levels.

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FUELING GOLD’S FUTURE ASCENT

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(Posted: April 4, 2013)

Gold has certainly taken a beating in recent days, giving up all of the gains attained during the Cyprus crisis — and down nearly 20 percent from its all-time high back in September 2011.

And, now having suffered two consecutive quarterly declines for the first time since early 2001, some analysts and investors are abandoning the yellow metal, proclaiming that gold’s decade-long bull market has run its course.

I’m no “gold bug” – but I couldn’t disagree more . . . based on solid reasoning and objective analysis.

Short-Term Shock Therapy

What the gold market needs to move higher is a good dose of Zoloft or perhaps, even more extreme, a high-voltage jolt of electroshock therapy to jog the metal’s price out of its current state of depression.

Perhaps this will come from across the Atlantic – where recessions are worsening, social discord is on the rise, and the euro appears vulnerable to further capital flight.

Maybe, unpredictably, it will come from some geopolitical upset – on the Korean Peninsula or in the Middle East.

Or, possibly, it will come from Washington’s inability to deal with its mountain of debt, lack of fiscal restraint, or the insidious and still barely apparent effects of sequestration on economic activity and employment.

More likely, the jolt needed to set gold firmly on its long-term upward trajectory will come from a renewed recognition by the Fed and the financial markets that still more monetary accommodation is needed to prevent the economy from stalling.  That’s what fueled the September 2011 run to record high gold prices . . . and this may be what does it again.

For now, gold’s short-term prospects remain uncertain. We could very easily see a further retreat, possibly to $1520 or even lower . . . but much of the recent selling is also price-sensitive — coming from gold ETFs and “paper gold” products in futures and other derivative markets — and will diminish quickly if prices dip much lower and traders begin to bet on the long side of the market.

Meanwhile, physical demand – from emerging-economy central banks and the private sectors in China and other Asian markets – remains strong and can be expected to strengthen further if prices continue their retreat.  As in the past, price-elastic physical demand will provide some downside insurance.

Gold’s short-term direction may depend largely upon the flow of outside news and black swan events, those surprises that seem to come out of the blue, rather than the internal fundamentals of the gold market.  Indeed, there is no telling whether the next move will be up or down.

Long-Term Forces

What I can say, however, is that the long-term bull market remains intact . . . and there will be sizable rewards for those with patience who stay the course.

I can also tell you that central bank reserve managers are not worried their gold assets will depreciate.  Indeed, they continue to buy more.  But many are worried about the prospective depreciation in the value of their U.S. dollar holdings and view gold as a legitimate monetary asset, diversifier, and insurance policy.

So what are the factors and forces likely to push gold prices higher?

  • First, the U.S. economy is doing worse than generally perceived — and thanks to recession in Europe, sequestration in America, and an enfeebled consumer on both sides of the Atlantic we are heading into economic doldrums or worse, a full-blown recession later this year. Anyone who thinks the U.S. economy is really in a sustainable recovery is just kidding themselves. ??As a consequence, the Fed will have no choice but to speed up its money-printing machine, even as inflation expectations begin rising.  Remember it was the successive waves of quantitative easing that juiced gold up to its record high of $1,924 in September 2011. The adoption of still-more aggressive monetary easing by the Fed later this year or in 2014 will again set gold on fire. Other major central banks will be under pressure to reflate along with the U.S. — and some, like the Bank of Japan — are already greasing their printing presses.
  • Second, the European economy — and the euro-zone monetary system — is under tremendous strain with the stronger economies increasingly unwilling to continue bailing out the weaker economies for whom there is no room for more forced austerity. Cyprus was just a warm-up of what’s to come. And, next time, it will be a big economy like Spain or Italy that goes belly up, triggering flight from the euro into both the U.S. dollar and gold.
  • Third, whatever may come, China’s appetite for gold will remain firm as the domestic market continues to mature. The introduction of new products and channels of distribution (like ETFs) will increase the efficiency of the domestic gold market . . . and increase private household demand. In fact, valuing private-sector gold holdings as a national resource, the Chinese government will continue to support and encourage private gold ownership — and the associated demand will continue to support the price of gold in the world market.
  • Fourth, emerging-economy central banks will continue to accumulate gold, especially at times of price weakness when their purchases are least visible. For some, it is merely a desire to diversify reserve assets and gradually wean themselves from over-relience on the U.S. dollar and the euro, which has now been totally discredited as a reliable reserve currency. ??But for China and Russia — the two central banks with the most aggressive gold-accumulation programs — increasing their gold holdings is undoubtedly part of grander plans to have the yuan and the ruble attain reserve-currency status.
  • Fifth, there has been a little recognized structural shift in the world gold market. Many of the “new” buyers of gold in recent years are accumulating gold, not as an ordinary investment to be sold at higher prices for a trading profit, but as a long-term store of wealth to be passed down to the next generation. ??This is true across Greater China where the emerging middle class has more money than ever before and has a cultural affinity and emotional attachment to the precious metal. It is true for the American and European high net worth families and the retail buyer of gold-bullion coins. And, it is true for many central bank buyers — not just China and Russia, but Mexico, South Korea, Kazakhstan, and many others — who are accumulating gold not as an investment, per se, but as a national legacy for generations to come.

Bidding Wars Ahead

Most of this newly acquired gold is in extremely “strong hands” and will not come back to the market except at much higher prices. As a consequence, the available supply of gold in the marketplace to satisfy future demand — what I call “free float” — is shrinking . . . and future buyers will be forced to bid up prices to higher and higher levels in order to satisfy their hunger to own more.

Jeffrey Nichols is Managing Director of American Precious Metals Advisors consultancy group and serves as Senior Economic Advisor to Rosland Capital LLC.

He has been a leading precious metals economist for over three decades. His clients have included central banks, mining companies, national mints, investment funds, trading firms, jewelry manufacturers and others with an interest in precious metals markets.

In addition to publishing his views online at www.NicholsOnGold.com, Nichols tweets regularly @NicholsOnGold

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GOLD BEARS BEWARE

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(Posted: March 15, 2013)

Gold bears have been a gleeful group of late, pointing to the recent decline in gold exchange-traded fund holdings as evidence of investor disinterest in the yellow metal.  Gold bears also see the market’s rather lackluster performance over the past year and a half - and the failure of prices to move higher - as further evidence the decade-long bull market has run its course.

Yes, gold has retreated some 20 percent from its September 2011 all-time high (near $1,924 an ounce) to its subsequent low (just over $1,520).

Yes, Gold ETFs have seen some substantial and high-profile withdrawals in recent weeks.

These developments in no way diminish my belief that the bull market in gold has plenty of life ahead with the yellow metal’s price doubling (or more) from recent levels in the next few years.

Historically, cyclical upswings in stocks, bonds and commodities have often been measured in decades and bull markets typically end with a rapid advance to record heights followed by a swift and resounding crash.  This looks more like equity markets today while gold’s appreciation over the past decade has been a measured advance and its recent performance bears no resemblance to a bursting bubble or a mania run its course.

The bears are also pointing to the recent strength of the U.S. dollar in world currency markets and the record highs on Wall Street as confirmation that gold is past its prime.

In my view, the appearance of dollar strength does not reflect a healthy currency.  The U.S. dollar is merely the least unattractive contestant in a beauty pageant of ugliness.  As such, flight capital, especially from Europe, seeking a safe haven has been gravitating to dollar-denominated U.S. Treasury debt.

Nor is the record-breaking streak on Wall Street a sign of a healthy economy.  Who could possibly believe that! It is a consequence of the Fed’s super-accommodative monetary policy and the need for many investors to register positive returns in a near-zero interest-rate environment.

What about the decline in global gold ETF holdings?  For all the attention in the financial press, the nearly 10-percent decline in gold ETF holdings from their all-time high in December really tells us very little about market fundamentals and price prospects.

First, it is quite possible that some of these sales were from institutional investors choosing to buy and hold the real thing, directly and under their own control, rather than hold a piece of paper representing ownership but not directly accessible by ETF investors.

Second, many hedge funds and institutional investors are driven by the need to perform well in short term - and simply could not resist jumping on Wall Street’s bandwagon where profits in the next month or quarter looked more attractive to them.  Once gold again shows some real life (and it will), those who jumped ship will get back onboard, expecting gold to deliver relatively attractive short-term gains.

Third, gold sold by ETFs has to go somewhere - and where it’s been going is of great importance.  On the other side of the market have been central banks, buying for the very long term and unlikely to re-sell anytime soon, perhaps not for decades or longer.  It’s as if the gold has been permanently removed from the marketplace and indefinitely unavailable to meet future demand - not just from ETF investors but also from investors and jewelry buyers of every stripe. This means that prices will have to rise much more than might be expected as more buyers compete for a smaller supply of available metal.

In fact, central banks are likely to continue building their gold holdings in the months and years ahead -so that available supply, what I call “free float,” will continue to shrink as gold moves from weak to strong hands.

Ironically, America’s former cold-war rivals - Russia and China - have been the biggest and most persistent central-bank buyers, followed by a diverse group of newly industrialized and emerging economy nations including Mexico, Korea, Brazil, Mexico, the Philippines, Kazakhstan, Ukraine and others.

Both Russia and China see central-bank gold accumulation as an important step toward playing more important roles in the evolving global economic and political order - while ending America’s dominance in the world monetary system.

Moreover, for those central banks under-weighted in gold and over-weighted in dollars and euros, their motivation has been to diversify their official reserve assets and reduce their exposure to the U.S. and European currencies.  With America unable to address its Federal budget deficit and limit its mounting sovereign debt and with economic policy on both sides of the Atlantic in disarray, central banks around the world have a strong incentive to buy and hold gold as a currency hedge and insurance policy.

When the dollar looks less attractive as a safe haven and easy gains on equities look less certain to investors, gold will once again be the leading beneficiary of the Fed’s easy-money policies.  In the meantime, support for higher gold prices will come from continued central-bank buying as well as strong private-sector demand from China, India, and retail buyers around the world.

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