The Tug of War on Gold Continues
Daan Joubert
It is getting almost monotonous to write that the gold price is primed to take off. Yet evidence shows that it is now subject to a more balanced tug of war than was the case some time ago. Up until earlier this year, any significant selling of contracts on Comex was a signal to buyers of bullion to withdraw from the market. The reason was simple - whenever a flood of contracts were thrown onto the market, buyers of gold futures were swamped and the price fell. Immediately, in sympathy, the price of bullion also came under pressure with sellers outnumbering the retreating buyers.
It must have become a conditioned reflex among buyers of bullion - see new offers on Comex proliferate and run for cover. If you are a manufacturer of jewellery or a user of gold for industrial reasons, you know you can afford to wait a while and then fill your order at a lower price. If you are looking to buy gold for reasons of investment, you could also wait for the lower price that is sure to become effective over the next few weeks or even reconsider whether you really want to invest in something of which the price is so volatile and uncertain.
But as written here before, the nature of the game has changed. More recently a new breed of buyer has appeared on the scene - or should one say that there are simply more and more determined buyers of physical gold in the market, which changes the way buyers behave. When the sellers appear in force on Comex they no longer run away to buy another day - or week or month - at a much lower price. Large buyers have to start buying while the price is still falling, else they cannot hope to obtain quantity.
This means buyers begin competing much earlier; they sit back for a few hours or a day or two at most in order to entice sellers into the market so that they can have their orders filled at a marginally lower price. The time is past that a buyer could wait for some weeks for the gold price to reach a bottom $20 and more below the recent high and then only begin to test the market. Competition for the available gold has become just too fierce for such complacency - which also says something about the availability of gold.
The last time the gold price really succumbed to a raid was at the end of May, when the price fell $30 over a period of a month and a half before bottom was reached. When it rebounded from the low of $342,50 on July 17 to trade at $365 less than two weeks later, the next raid saw the gold price lose only $20 in five days before beginning a new rally.
This rally saw gold above $390 before sellers again appeared in great number on Comex and - with the anniversary of the Washington Accord behind us - also scope to attack the physical market with new supplies from central banks. This combined assault again took the gold price down by not more than $20 over a period of two weeks, after which the price again rebounded into the mid $380's, where the tug of war is now intensifying.
It used to be the rule that the gold price would rise during Asian and European trading and then get hammered down, back into submission, during US trade - generally with the gold price ending the trading day near or at its low. This too has changed: while gold still tends to do well early during the trading day, and still gets knocked back in US trade, the day's low now comes well before the US Comex close with the gold price staging a come-back during the last hour or two of trading.
This is compelling evidence, if circumstantial, that demand for bullion is getting so great that Comex has much less influence than before over what happens to the gold price.
We know that open interest on Comex gold contracts has been at record levels and is holding up well under severe selling pressure, even though a large open interest has traditionally been an indication of increasing vulnerability and instability. It might be that the holders of long contracts have hedged themselves by buying put options, while the holders of short contracts have bought call options as security against a spike in the price.
The extent of the options market is staggering - 460 000 calls and 290 000 puts. At 100 ozz per option, there are potential calls on 46 million ounces of gold - equal to over 1360 tons of gold or half of annual mine production. If the gold price should spike to say over $400 before the December option expiry, so that the majority of these options kicks in, there will be chaos in the market with financial blood running knee-deep in the pits. Even if this happens later, after expiry of the near term options, the effect should still be earthshaking - and not only for the bullion market, as the waves that result from such a massive set of new claims on gold will crash heavily onto other markets, and financial institutions as well.
Waiting in the background and perhaps soon to stoke the fires in the gold engine room is the Blanchard suit against Barrick and JPM which is on the verge of going into discovery - and thereby raising the possibility of hauling more than just one set of skeletons from the closet.
Interesting weeks ahead - with the tug of war heating up and the probability of gold really breaking loose improving almost day by day. Exciting times really, except if one were on the wrong side of the market and therefore feared what would come your way if gold broke above $400 and stormed ahead.
Definitely not the time to be short of gold; On the other hand, perhaps not yet the time to be fully invested. That can come when gold breaks $400.
10 November 2003
© November 2003 Daan Joubert
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