Gold bubble showing signs of strain

Good Morning,

The lowest price in three month, achieved after Tuesday’s brutal sell-off, lured some price-conscious Indian buyers back to the bazaars overnight. It might even turn out to be the case that July’s gold sales in India end up being the best of the year thus far. As we have often noted, it is [almost all] about price, when it comes to that demand (that, and the calendar, but in that order). In the West however, the trend towards lightening up on the previously huge gold positions and seeking “greener” pastures in other assets remains intact, albeit even as of the latest tallies gold still shows outperformance versus the stock market.

For now, the bears hold the market’s flag firmly in hand, and bullion appears to want to be heading towards or below its 200-day moving average of around $1,149 an ounce. Such a direction appears to receive confirmation in one of Barclays Capital’s latest market observations: “Taking a closer look at the price action from the June 21 highs (near) $1,265, the decline can best be described as corrective... with downside targets seen to the 200 day average, now $1,147,"

“Gold is in full collapse, as people exit the gold bug bus,” wrote analyst David Lutz, on Tuesday. Meanwhile, Michael Shaoul, CEO Oscar Gruss brokerage, notes that “the fact that gold’s weakness comes at a time that the USD is losing ground against other major currencies means that the USD price masks the losses measured in other currencies. The price of gold in AUD (our favorite neutral measure of price) has broken down through multiple support levels in recent days and at $1,297 is now over 15% below its 2010 peak of $1,527 … We remain concerned that an overcrowded trade such as this has the potential to unravel quickly if participants seek to trim positions.”

Market Beat warned on Tuesday that the “concern isn’t over the savvy types who know full well that this is a bubble and have been riding it for as much gain as they can take. (Yes, we’re looking at you Mr. Soros.) Our concern is for the people who are buying the yellow rock because it’s been hawked to them incessantly on TV. Mark our words, when this thing pops a lot of people who can’t afford it are going to get hurt.”

This morning’s opening gold act in New York was meek, at best. After having tried for a bounce back towards the $1170 level overnight, bullion opened with about a 60-cent gain and was quoted at $1162.20 on the bid side. Silver was off by 4 cents at the midweek session’s opening, quoted at $17.60 the ounce. Platinum eked out an opening gain, rising $7 to start at $1534.00 while palladium remained static at $466.00 the ounce. Rhodium showed no change at $2230.00 after yesterday’s small loss of $20.

Market focus this morning centers on durable goods orders in the US. Not so good, that number. It sank rather swiftly in June, tallying a 1% loss. That is diametrically opposed to the expected 1% gain among polled economists. It also happens to be the largest such drop since one year ago. Not a dollar-helping number, that. In the wake of the number, the greenback showed only a modest 0.07 decline on the index (at 82.09). The euro continued stable at just under $1.30 vis a vis the US currency. Oil was flat.

Maybe this day’s statistic, and the fact that it could possibly be a precursor of a not-so-hot GDP figure to be reported on Friday, will give gold a near-term reason to undo the string of losses recorded over recent sessions. Recall that the precious metal had found excuses to drop in new home sales, consumer confidence, the lack of bad news from Europe, etc. Then again, if the overriding sentiment by Friday’s markets’ closing time is that deflation is starting to grip the US economy’s neck with a firming hand, who know? Asset liquidations could still ignite, a la 2008.

Here is a truth from Minyanville’s Todd Harrison, which, can apply to a number of asset classes currently in limbo and under renewed examination by investors. Todd opines that when the tide turns on a particular market, the phenomenon is not about dislike: “The opposite of love isn't hate, its apathy. We've noted the lower volume during rallies and the higher traffic during the declines -- a sign of distribution -- but a simpler truth may be emerging, that of burnout. After four -- or five, or six -- bubbles and bursts, folks are both bitten and shy by the gamesmanship in the marketplace.”

This “gamesmanship” is what worries this scribe the most. In particular, one game called the “ETF.” We have alluded to the potential pitfalls of going up against the big boys in a previous commentary. Now, a full-decibel warning is in order. Bloomberg Businessweek does ring just such an alarm bell, in a devastating cover story titled “Amber Waves of Pain.” [triple sub-titled: “Do Not Buy Commodity ETFs”]

Make no mistake, the findings can be applied to gold and could eventually make the ETF the biggest (but not necessarily the most positive) story to ever come out of this market. If you only feared the potential accelerative effects on a declining gold price from massive ETF redemptions, well, fear on. However, read what other landmines are to be found in this enticing-looking landscape:

“An ETF, which can be bought or sold like a stock, attempts to track the price of a particular basket of assets—tech stocks, for instance, or high-yield bonds, or commodities ranging from wheat to gold to oil to natural gas. The commodity ETFs were supposed to offer a hedge against equity losses, but in the crash of 2008 everything fell in tandem.” So far, not so good. That which you thought was a good hedge, may not be so…

Now, enter that “Dancing With The Hedge Fund Stars” word again: “CONtango.”

Contango is a word traders use to describe a specific market condition, when contracts for future delivery of a commodity are more expensive than near-term contracts for the same stuff. It is common in commodity markets, though as Wolf and other investors learned, it can spell doom for commodity ETFs. When the futures contracts that commodity funds own are about to expire, fund managers have to sell them and buy new ones; otherwise they would have to take delivery of billions of dollars' worth of raw materials. When they buy the more expensive contracts—more expensive thanks to contango—they lose money for their investors. Contango eats a fund's seed corn, chewing away its value.” Still enchanted with ETFs?

Okay, then enter another word we recently made mention of: “pre-rolling.”

Contango isn't the only reason commodity ETFs make lousy buy-and-hold investments. Professional futures traders exploit the ETFs' monthly rolls to make easy profits at the little guy's expense. Unlike ETF managers, the professionals don't trade at set times. They can buy the next month ahead of the big programmed rolls to drive up the price, or sell before the ETF, pushing down the price investors get paid for expiring futures. The strategy is called "pre-rolling."

Enter the former Deutsche Bank lawyer who helped open the floodgates for the commodity-based ETFs, who “now says something has gone wrong. Like most things on Wall Street, they have been over-marketed. The complications have been glossed over. I'm not sure the people marketing them even understand the complications, and that's a shame."

The lawyer in question left Deutsche in 2008 and is now pursuing a career as a stand-up comic in New York. This, while certain commodity ETF managers already have a full-time career in the same field. Except they are the ones laughing (all the way to the bank, with your money), not the audience.

Happy Dancing. If You Are Nimble.

Jon Nadler is a Senior Analyst at Kitco Metals Inc. North America

About the Author
Jon Nadler Jon Nadler is a Senior Analyst at Kitco Metals Inc. North America
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