Gold shorts lose pants and leave

The gold market is in serious turmoil. The only place that isn’t featuring ruptures is the gold price itself.

In fact, gold volatility is falling. But everything else in the world of gold trading is downright chaotic.

Eventually, the price will be affected by all this. Which means now is your chance to position yourself for gold’s bull market.

Find out why gold is about to begin a new leg up next.

Find out how to profit here.

It all began with a shortage of physical gold in New York in March.

A Swiss town with some of the world’s key gold refiners got laid low by Covid-19. It turns out that gold isn’t so fungible – one lump of gold is not like another one. Mostly because the standards for delivery are different in different jurisdictions. They require different sizes, weights and shapes.

And so the supply of gold suitable for delivery under Comex futures standards suddenly dried up. This caused the price between London and NY gold to diverge by up to $70.

The divergence got large enough that the Perth Mint in Australia started producing gold bars to NY Comex standards and flew the gold 11,000 miles to NY on Covid-grounded passenger jets. Bloomberg covered the extraordinary story at the time:

Gold Bars Are Flying 11,000 Miles to New York to Ease Supply Squeeze

Australia’s largest gold refinery has ramped up production of one kilogram bars to ease the supply squeeze in the U.S. that helped propel a surge in the premium for New York futures.

The collapse in air travel that’s grounded passenger jets — frequently used to transport gold products — and virus-related disruptions to some refining capacity has tightened availability of the rectangular bars, typically used to settle the Comex futures contracts.

“We’re producing as many kilobars as we can, we’re probably churning out seven and a half tons of them a week at the moment and we are forward sold well into May,” Richard Hayes, chief executive officer of the Perth Mint, said in an interview. “A very large portion of those kilobars are ending up as Comex deliveries.”


But here’s the important bit: the banks that are active in the London gold market often hedge their long positions in physical gold in London by selling gold futures in New York.

This drives a lot of the gold conspiracy and controversy, because it looks like gold-dealing banks are short gold. But it’s about gold market makers avoiding being long gold on a net measure across the two jurisdictions.

The Financial Times explains:

The price of gold is based mainly on physical trading handled by banks in London, where HSBC and JPMorgan dominate. They typically take a short position in gold futures in New York to hedge their exposure to a fall in the spot price.

The danger with hedging in a different market is that the prices can diverge. When the NY price surged ahead of the London price, the market makers were short in NY and long in London. It couldn’t have been worse.

HSBC lost $200 million in one day.

Canada’s CIBC lost $64 million in a day.

In the case of HSBC, this was vastly more than the bank’s regulatory Value at Risk (VaR) models were supposed to allow for. (VaR was the key risk measure which made sub-prime related investments seem safer than they were for banks holding them. When volatility spiked, VaR rules required banks to sell out to reduce their risk, and that triggered the real crisis.)

But let’s stick with gold. Because after the NY shortage came the NY glut…

Bloomberg now reports that “The New York gold market has been flipped on its head in just a couple of months, with a scramble for the metal turning into a glut.”

And the glut is causing quite mess. There’s even a version of the oil futures fiasco emerging.

Back when oil faced an OPEC and Covid-19 glut, there was so much oil that traders panic sold their positions to avoid having to take delivery of the oil. The real world suddenly made futures markets move instead of vice versa. The oil price went deeply negative.

In the gold market today, traders are selling out to avoid having to take delivery too. But there’s so much physical gold waiting for someone to take it that the sellers are having to offload it regardless.

This explains the recent weakness in the gold price. Although it didn’t last because of the longer term outlook.

The futures curve for gold shows the price at which gold for future delivery can be bought and sold.

Source: Denver Gold

As you can see, the market is in contango. Which sounds interesting, but it’s the normal situation. Prices are expected to go up over time. You can buy or sell gold for delivery in the future at higher prices than the sport price today.

But here’s where things get interesting.

Because the banks got burned in March, they may become cautious about shorting in NY from now on. The Financial Times has the figures:

Comex gold futures trading volumes have since dropped — a fall that market participants attribute in part to lighter activity from banks. Since January, the total number of outstanding gold futures contracts on the Comex exchange has fallen more than 30 per cent.

Scotiabank, one of five key banks in the London gold market, closed its gold business in April. And that’s not all, reports the FT:

Canada’s Scotiabank is withdrawing from the gold market and said this week it had set aside $168m to cover the closure of those operations and a separate US government investigation into its activities.

Those “activities” are likely suppression of the gold price.

The point I’m making here is simple.

A huge source of selling pressure in the paper gold market just got punched in the nose. And it’s currently refusing to come back for more. Without that selling pressure, the gold market will look different.

I believe it will boom because a huge amount of “fake” paper supply is coming offline. (Speculators and hedges selling gold futures without the intention of selling gold.)

But it’s not just supply. This Bloomberg chart shows that gold-backed ETF holdings have grown for six months in a row. Gold is going mainstream as an investment, generating vast demand for physical.

Source: Bloomberg

Rising demand, falling futures selling pressure. I wonder what might happen…

But how do you take advantage?

Well, there are already plenty of reasons to buy gold. But what I’m suggesting you do today is speculate on a surging gold price in addition to this.

Our gold stock analyst has compiled the best gold mining companies to buy.

If you ask me, now is the time.

Nick Hubble
Editor, Southbank Investment Research

Category: Commodities

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