Is the gold price manipulated? Part III
Second, futures markets drive the spot market prices (to a large extent). The academic literature points out that stock and currency futures markets lead spot markets in terms of information and price discovery. Why would it not also be the case for the gold market? Investors should realize that the gold futures market is simply much larger and liquid than the spot market. It also enables investors to use leverage and not take delivery. In other words, thanks to the special features of the gold futures market, traders on these markets react first to the latest developments.
Future exchanges exist in many countries to facilitate trade of asset classes, like stocks, commodities, currencies, bonds, stock indices, etc., but nowhere do they arouse such emotions as within the gold investor community. Many people accuse bullion banks of selling uncovered shorts on the Comex (the most important gold futures market) to drive down the price of gold. They believe that this manipulation works, because most players have no intent to deliver or take delivery of gold.
However, this is how the future markets work. The majority of transactions in the futures markets (not only gold) are without physical delivery and are cancelled out by purchasing a covering position, because it is a much more convenient way of settling the contract and gaining exposure on the price movements. The impact of ‘naked’ shorts is more controversial, but this academic paper about ‘naked’ shorts in the stock market shows that uncovered shorts were reacting to fundamental signs of financial weakness. If short sellers on the Comex were really as uncovered as it is claimed, there would be a huge ‘short squeeze’ and the price of gold would rise. Therefore, any manipulation using ‘naked’ shorts would be short-lived. If banks had massive short positions in the gold market, they would have to buy large numbers of futures contracts to cover their position and buy the physical metal to deliver it or roll their positions, by buying expiring contracts and selling the next one out. In all cases the short-term impact of selling the futures contract would be reversed as banks would have to unwind their positions (investors should also not forget that for each seller of a futures contract there must be a buyer). Thus, this practice, existing or not, cannot explain the long-term bear markets in gold.
Although many people talk about a disconnection between ‘paper gold’ prices and physical demand, these claims are unfounded. The futures markets often lead the spot gold market because they are faster and more information-sensitive. Then, the international gold price becomes the basis (adjusted for premium) for the bullion prices quoted by bullion dealers. The short positions in the gold market form a part of the futures markets (for example, as a part of hedging). Some of participants may also engage in ‘naked’ shorts, but their suppressing effect on gold prices (assuming that these shorts do not reflect fundamentals) would be only short-lived. There is usually contango in the gold market – i.e. the gold futures (allegedly manipulated) are traded at a premium over spot – which refutes the theory about big banks constantly selling uncovered shorts to suppress the price of ‘paper’ gold.
Consequently, it might be a better idea to focus on other reasons for buying gold instead of doing so only based on the possible collapse of Comex. There are many reasons to hold gold as insurance, to invest in it (given favorable circumstances) and to trade it for short-term profits. We’ll continue to provide our fundamental and trading analyses to increase the profits that can be achieved thanks to participating in the precious metals market.