Commodities | Mar 12 2007
By Greg Peel
Investing in gold can be a heartbreaking experience. Day after day, everyone from single-minded gold bugs to respected economic analysts suggest gold must go higher, and that a move back to 2006 peak levels is not out of the question. But since the collapse in May last year, it’s been a long and volatile road back.
Such it was once more just when gold had US$700/oz in its sights prior to the Chinese market scare. However, even before China did its thing gold was finding it difficult to break through the US$690/oz level.
Respected analyst and gold trader Dennis Gartman noted on March 1st that “despite the fact that we are long term bulls of gold, we find it disconcerting that spot gold has seemingly badly failed in the past two or three days to push upward through $685-690. Whoever, or whatever, the seller is at that level, it has been formidable indeed”.
Gartman knew exactly what conclusion would be drawn in certain circles regarding who that seller might be:
“We care not who the seller is. GATA may, and certainly GATA may make much of the implications that one might draw from some nefarious, governmental force that is the seller. We care not. That is an argument that neither we nor they shall win. What is important is that gold has failed to advance under circumstances that might otherwise have been considered quite bullish of it.”
Gartman was not surprised by the sell-off which transpired following the Chinese debacle. While collapsing share prices should otherwise be bullish for gold, he remained quite cognisant of the sudden need for liquidation. At US$673/oz Gartman exited his long gold position. At US$637/oz he came back in. As gold has now held above US$647/oz, Gartman has built on the position.
And he was certainly right about one thing. The Gold Anti-Trust Action (GATA) committee had no doubt as to who the seller was above US$685/oz in the first place.
As the gold price rose towards the US$690/oz level, there was a huge build up of open interest in Comex gold futures. What does this imply?
A futures contract does not exist until one buyer meets one seller at a price. At that point there is an “open interest” of two contracts – one short, one long. Thereafter, a new buyer at a higher level might either meet a new seller, or the previous buyer selling out. If the new buyer meets a new seller, open interest has increased to four contracts. But if he meets the previous buyer selling out, the net result is only three (one ceases to exist).
Had the original seller capitulated and bought back from the original buyer, the open interest would be zero, as both contracts would be negated.
Traders in all markets watch futures open interest movements very closely. They are an indication as to whether the speculators/investors in the market are getting long or short. This sounds a bit counter-intuitive, for the reality of futures contracts is that there must be a buy for every sell, implying a net square position. But if a market is on the rise, and open interest is rising as well, the implication (particularly in the gold market) is that it is investors building up long positions. The seller is possibly a mining company hedging production, or perhaps a central bank affecting gold sales. It is unlikely to be investors coming the other way, for in a rising market sales by investors will be to take profits. Investors never start out going short. If it were investors selling, the open interest would fall.
When open interest builds to a significant level in a rising market, it follows that downside pressure will also build. If the price does continue to rise, at some point the longs will look to cash in. If the price begins to fall, then chances are the longs will look to bail out in a hurry.
And guess what? That’s exactly what happened last week. Not only were the longs caught out, the world in general, and the Chinese in particular, were liquidating their physical holdings in a desperate attempt to raise cash against losses in equity positions. The longs were caught in a vacuum.
The other implication of the build up in open interest in gold futures was provided by the fact that the price had stalled on approach to US$690/oz when everyone was expecting US$700/oz to be just around the corner. If open interest is building and the price isn’t moving, the buyers must be hitting a wall of selling. And as Gartman noted: “Whoever, or whatever, the seller is at that level, it has been formidable indeed”.
The Commodity Futures Trading Commission in the US reports weekly on futures positions based on the size of the firms that hold them. It did not escape avid gold writer and GATA supporter James Turk that the big sellers were the so-called “gold cartel” – those large global investment banks who act on behalf of central banks.
GATA’s accusation is that the gold cartel has long been acting to suppress the gold price in order to maintain the value of the world’s reserve currency – the US dollar. The cartel is able to sell vast amounts of gold futures (paper gold) to achieve this, such that the central banks need not run down their actual physical holdings. GATA is convinced that this practise is destined to reach a breaking point at which the central banks will no longer have the firepower to hold back the tide.
But in the meantime, the gold cartel can simply sell into the market with enough weight behind it safely knowing that the longs will eventually break, and the subsequent sell-off will allow for short positions to be unwound. It doesn’t always work however, as the 2005-06 run up to US$725/oz is testament to. Turk maintains that the cartel was also unsuccessful in holding gold in the US$640s and US$660s recently. It wasn’t until the US$680s that the cartel got its break. Thank you China.
Turk is confident that despite the gold rout of the last two weeks, the technicals are still bullish. “We can take solace from the fact that gold is in a long term uptrend”, says Turk, “clearly indicating that the gold cartel is losing the war”.
Dennis Gartman “cares not” who is selling gold. Many participants in the gold market scoff at GATA’s claims. Nevertheless, the gold derivative market is alive and well and often subject to waves of selling meeting waves of investor buying.
This is yet to dampen the enthusiasm of just about every major broker and analyst in the FNArena database and beyond who have pitched their average gold price valuations for 2007 at either the high $600s or above US$700/oz.