Imperfect precious metals markets

Those believing in the theory that financial and commodity markets were perfect should have a look at the development of gold, silver and platinum during this past week. The major fundamental factors for the fair valuation were more or less neutral. Nevertheless, these three metals posted stronger losses between 2.1 and 5.2 per cent. Only palladium ended the week marginally higher.

The precious metals came under selling pressure on Monday and Friday. The reasons for the losses provided by market reports are demonstrating that markets do not react rationally. On Monday, analysts blamed the debt crisis in the eurozone as one reason for the losses. However, there were no news out of Spain and as we pointed out last week, it is not very likely that the Spanish PM would be forced to resign and that snap elections would have to be held. Fears about the Spanish government are like a storm in a tea cup. It was also quite clear that the meeting of eurozone finance ministers would not lead to a decision on a bailout for Cyprus as politicians wait for the presidential election before taking a final decision. In Italy, former PM Berlusconi reduced the difference in opinion polls to Mr. Bersani, who was still in the lead. And that Pope Benedict announced his resignation is by no means a reason to sell gold.

The second reason for the drop of precious metals prices on Monday was according to a market comment from Barclay’s the start of the lunar new year celebrations in many Asian countries. As Chinese investors absorb supply, analysts at the British investment bank feared that supply would weigh on prices in other trading centers. However, as the date of the lunar new year is not coming as a surprise and well known in advance, it should have been discounted already in the prices. Furthermore, if buyers of precious metals form rational expectations, they should have expected that prices might be under pressure when China is out of the markets for the week long holidays. Thus, a rational investor would defer buying to profit from the expectation of declining prices. Therefore, demand should have shifted towards the holidays in China and this should compensate the lack of demand from Chinese investors.

On the other hand, also short-sellers would know that Chinese investors would not be in the market during the lunar new year holidays. Thus, they also might defer selling short to have a stronger impact on pushing prices down. However, in this case, they would have to lease gold to meet the obligation to deliver in the spot market. As a result, gold lease rates would have to increase. Gold lease rates increased only slightly on Monday. Stronger increases took place later during the week and the week before. Nevertheless, the development of the gold lease rates indicates that large speculative investors are getting more bearish on gold. This is also confirmed by the recent CFTC report on the ‘Commitment of Traders’, which showed a further drop of the net long position held by large speculative accounts from 137,465 to 126,835 futures contracts at the CME’s COMEX division.

Unlike some well-known bond fund managers, who appear to talk their book almost daily on a television station, many hedge fund managers holding gold make no comments in public about their investments in precious metals or ETF’s on physical metals. Thus, the public has to wait until the filings of those hedge fund managers with the SEC will be released. During the final quarter of 2012, there were already indications that hedge funds turned more negative on gold. One of those indications was the development of the net long-positions in the CoT report. Now, the SEC filings revealed that Soros Capital and some other major hedge funds (Tiger, Moore) had reduced their investment in the SPDR Gold Trust ETF considerably in Q4 2012. This information was the trigger for the sell-off on Friday.

From a movie title, we know that “the postman always rings twice”. Many investors and traders appear also to react twice. The selling of shares in the gold ETF took place in the final quarter of 2012. When gold priced headed lower, they followed the price momentum and also sold. Now, they received the information why gold traded down some month ago and sell again. This is not a rational behavior but just following the herd instinct. First, the SEC filings provide no indication that Soros Capital and other hedge funds still reduce their position in the gold ETF. The selling in Q4, despite being massive, could be just part of reallocating funds to investments, which appeared to be more lucrative. It was also reported that Soros Capital made a gain of more than 1bn US dollars in speculating on a weaker yen, since it became official policy in Japan after the victory of PM Abe in November. Second, despite the liquidation of positions by major hedge funds, the gold holdings of the SPDR Gold Trust increased in Q4 by around 30 to 1,350.8 tons. However, since the start of this year, they fell back to almost the level at the beginning of Q4.     

Technically, gold is in a difficult position. With the plunge on Friday, gold has fallen below two stronger support levels, but managed to close above the lower support level at 1,600$/oz. The trend following indicators turned bearish and the increase of the ADX indicator points to a strengthening trend behavior of gold after many months of range trading. However, it is not yet an all clear for gold bears. First, the stochastic oscillator points to an already oversold market. Second, two support lines cross at 1,584$/oz, which is another hurdle the bears would have to surpass. Thus, a test of this support zone might be a good buying opportunity as long as the fundamental factors for precious metals remain positive.