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Dark Pools, Program Trading and the Price of Gold

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(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.