Gold Price Movements during the US Government Shutdown

While the US government was shut down, we were also offline for almost two weeks. However, this was not related to any political decisions but due to some technical problems.

In this blog, it has always been argued that it is not just one factor having an impact on the development of precious metals prices. Nevertheless, we were surprised by the price movement of gold since the last Friday in September. Already at this weekend, it was obvious that there would be no last minute compromise to pass the budget in time and that the government shutdown was unavoidable. Given the stance of the Tea Party fraction within the Republicans, it was even doubtful whether the debt ceiling would be increased right in time to avoid a default of the US Treasury. Therefore, it was rather likely that the FOMC would postpone a decision to taper the bond buying program further into the future. Now, recent comments from some – even hawkish - FOMC members point in this direction.

In addition, the political wrangling in Washington DC argued for a weakening of the US dollar as foreign investors might reduce holdings of US Treasury paper and repatriate the funds or invest in more secure government bonds like UK Gilts or German Bunds. And indeed, as the risk of a default of the US government increased, the US dollar index declined, which reflects a weaker US dollar against the major currencies.

Thus, there were three factors – safe haven demand, postponing of tapering by the FOMC and a weaker dollar – pointing to a firmer price of gold and other precious metals. But gold was during this past three weeks the weakest precious metal. Even after the rebound following the last minute compromise to lift the debt ceiling for buying time for further negotiations on the budget, gold is still ended the trading week below the close of the last Friday in September, while all other precious metals posted gains on balance during this period.

Thus, the question is, why did gold trade lower to around 1,250$/oz and then rallied 65$/oz after the US Congress passed the bill to increase the debt ceiling? One possible answer might be a trade recommendation issued by Goldman Sachs to go short gold. The precious metals analyst of Goldman Sachs recommended to short gold already earlier this year and he was right in the second quarter. Thus, some large speculative accounts might have followed his recommendation. This would also be a possible explanation for the stronger price swings at the open of the gold futures trading session at the COMEX division of the CME group.

Unfortunately, due to the government shutdown, the CFTC had not been able to release the weekly “Commitment of Traders” report. The only available data is on the gold holdings of the SPDR Gold Trust ETF. Over the last three weeks, the gold holdings in the ETF dropped from 906 to 882.2 tons. It is well known that the whale in this ETF is John Paulson and his hedge funds. The performance of his funds was very poor in the first half of 2013. Thus, some investors might have regarded the recovery of gold during the third quarter as a good opportunity to withdraw money. Therefore, forced hedge funds liquidations might be another reason for the weak start of gold into the final quarter of 2013. However, even if John Paulson had been forced to liquidate positions in the SPDR Gold Trust ETF, it would not explain the strong rebound of gold after US President Obama signed the bill to increase the debt ceiling and to re-open the government.

Many commentators attributed the strong rise of gold to short-covering. The trading volumes of gold futures at the CME are no proof for this theory as for each contract bought there is one contract sold. Fortunately, there is other data available, which could provide some clues about covering of short positions, the gold forward rates – or short GoFo – as provided by the LBMA and the corresponding gold lease rates.

In mid-September, the 1mth gold forward rate turned positive again and rose up to 0.122% by the end of last month. During the first two weeks of October, the 1mth GoFo edged lower, but clearly remained positive. The picture changed completely during this past week, with the 1mth gold forward rate falling from 0.08 to -0.06% and the gold lease rate for the same maturity increased from 0.09 to 0.235%. The movements for other maturities are similar. Often, a rise of the gold lease rate is accompanied by a fall of gold inventories held in CME warehouses. But this was not the case this time. While the gold lease rate rose, the gold inventories remained unchanged until Tuesday and the decline on Wednesday was not at an unusual size.

Central banks play a major role in the gold lease market. However, they are also a major gold investor. In a recent report, central banks as a group had been criticized as being the worst gold investor buying at the peak and selling at the low. Furthermore, depending on accounting rules and book entry levels, the revenues from leasing gold might not be sufficient to compensate the loss due to write downs on gold holdings. Thus, central banks might have become less willing to lease gold to hedge funds, which speculate against central banks as gold investors.

Thus, the rise of gold lease rates and less gold available for leasing is probably the reason for the rebound of gold. Hedge funds following the advice of Goldman Sachs to sell gold short might have still made some profits. However, those profits are much smaller than the ones during the second quarter. The reason that Goldman Sachs trade recommendation was less successful or even might have led to losses for some short sellers is a basic mistake of the precious metals strategist. He obviously violated the old rule that one should never fight against the central banks.