PM End of Week Market Commentary - 8/24/2013
Gold finished Friday up $25.50 on above average volume to 1396.40, with silver up $1.01 to 24.05 on heavy volume. The gold/silver ratio dropped to 58.08, a level last seen in April prior to the gold crash. A poor new new home sales report was the catalyst for the week's big move; bad news in housing means (presumably) a lower chance of tapering at the next Fed meeting. PM prices closed the week at or near their highs, which is a good sign.
Over the week gold is up $21.30 [+1.55%] while silver is up $0.86 [+3.71%].
The dollar this week was largely neutral again, up 0.06 [0.07%] to 81.41. The dollar remains in a medium term downtrend, although momentum appears to be slowing as the dollar seemed to find some support at 80.75. While this week the buck was not a factor for PM, moves down in the buck are generally supportive of PM prices, while moves up will provide headwinds.
The gold/silver ratio has descended from its peak at 67 on July 28th to its current level of 58 in only a month. It is right at the 200 day MA for the ratio. A falling GSR is a bullish sign.
Mining shares were up on the rally in PM Friday; GDX +2.62%, and GDXJ +5.43%, with the juniors outperforming. Volume was heavy in GDX, but the price action was a bit lackluster. While gold has clearly broken out setting a new cycle high, GDX has not done so. For the most part, miners have traded sideways this week - with GDX up only +1.17%, and GDXJ +4.93% overall this week. As of now, the miners have not confirmed the breakout in PM, which I interpret as a bit bearish.
Here are the two charts: you can see that gold had a breakout, while GDX did not.
Physical Supply Indicators
* Gold premiums in Shanghai dropped $3.88, closing the week at a premium of $4.39.
* The GLD ETF gained +4.81 tons of gold this week.
* The COMEX lost -0.90 tons of registered gold this week, the losses coming largely on Friday.
* LBMA GOFO and Gold Lease Rates were virtually unchanged.
* Premium/Discount to NAV: Based on 16:00 EST Friday prices, gold 1396.30 and silver 23.99, CEF 16.33 -2.25%, PHYS 11.65 -0.08%, PSLV 9.64 +2.89%. Compared with last week, Sprott's fund premiums dropped somewhat, while CEF's discount improved.
The physical ETF premiums are more or less even, Shanghai premiums are disappearing, and GLD ETF has put in two straight weeks of increasing gold holdings. COMEX registered gold is still dropping, however, so I'll label the supply situation as mixed. Overall, rising prices appear to continue helping the gold physical supply situation, but let's call the supply situation mildly gold-price positive.
I have an explanation for negative GOFO rates later on in the report.
The COT report for gold shows the Producer category reduced both long and short exposures this week, with long exposures dropping more than the shorts, netting out to a drop of 5,000 contracts or about 5%. Managed money more than made up for this by dropping shorts and increasing longs by a net of 10,000 contracts, a big move. Smart money is taking some profits and managed money are both covering shorts and increasing long exposure. Positioning is still bullish.
Moving Average Trends [20 EMA, 50 MA, 200 MA]
Gold: short term UP, medium term NEUTRAL, long term DOWN
Silver: short term UP, medium term UP, long term DOWN
Gold this week moved from medium-term down to neutral, and silver moved from medium-term neutral to up. Things continue to look good for PM from the trend perspective; even if PM were to track sideways, the moving averages would continue to move up.
GOFO, LIBOR, and Gold Lease Rates
Negative GOFO rates have been considered by some to be the harbinger of an imminent default at the LBMA. In some sense, the question to be asked is, how on earth could Gold Tomorrow be worth less than Gold Today except as an indication of a potential default in the offing. But is an impending default the only reasonable explanation?
Looking at history, I've concluded that negative GOFO rates are not a sign of a coming gold-supply-apocalypse, but rather an artifact of an increasing Gold Lease Rate (GLR) combined with a very low LIBOR rate. Viewing charts of GOFO without understanding LIBOR's movements are potentially deceiving. Since GOFO = LIBOR - GLR, as LIBOR moves closer and closer to zero, GOFO = -GLR. And, the 6 Month LIBOR is at its all time low of 0.39% - it has never been lower than this in the history of the timeseries. This simple math means, if the GLR moves above LIBOR [and historically the GLR was often > 1% from 1990 - 2002], GOFO goes negative. If LIBOR had been 0.39% during the 1990s, GOFO would have been negative for all of that time.
My conclusion: negative GOFO rates are all about an all-time-low LIBOR, combined with a mildly increasing Gold Lease Rate. A GLR over 0.40% is nothing historic; therefore the "historic" negative GOFO rates are all about LIBOR's historic lows along with some mild moves in the GLR.
I'm not saying a supply shortage does not exist. All I'm saying is, negative GOFO rates aren't "smoking gun" evidence of this with LIBOR at 0.39%.
Why Did Gold Lease Rates Increase?
So half the story is about historically low LIBOR rates, and the other half is about an increase in the Gold Lease Rate. The next question is, what made the GLR rise? Perhaps its an impending default at the LBMA?
This article describes gold leasing and its associated mechanisms. http://www.silveraxis.com/commentary/gold_silver_leasing.pdf. One excerpt I found possibly explanatory is the following section:
3) Gold mining companies can upset the gold swap market and create conditions that make it lucrative for banks to engage in gold "leases" and other transactions as a result of mining company hedging activities that create an artificial short supply of futures and forward contracts, thus depressing the Gold Forward Offered rate.
Translated, that means when mining companies in aggregate start to hedge more, they dump a bunch of short futures contracts onto the market further out in time than the front month contract, depressing the price of "gold tomorrow" vs "gold today" - exactly what we are seeing right now in negative GOFO. I believe that mining company hedging is causing GLR to slowly rise.
How does this work mechanically? One futures contract instance exists for each month in the future. You can't have a futures contract without an expiration date: December 2013 Gold is the current front month. So presumably, a mining company that wants to lock in gold prices (and thus assure themselves of a profit) would sell a number of contracts at different dates further into the future than the current month.
Imagine a company completely hedging a 1 million ounce annual production: it would have to sell 833 (100-oz) contracts for each future month; 833 Jan 2014, 833 Feb 2014, 833 March 2014, approximating the expected production rate of the mine. This additional "supply" of futures contracts would depress future prices relative to current prices. If enough companies did this, "gold tomorrow" would eventually end up being worth less than "gold today" especially with the absurdly low LIBOR rate. Perhaps a month ago, Dan Norcini at http://traderdannorcini.blogspot.com/ talked often about miners increasing their hedging as a result of the gold crash, using evidence he found in the gold COT reports at the time.
From a business perspective, this sort of activity makes sense. If you ran a gold mining company, perhaps you too would find it worthwhile to lock in a slightly lower price that guarantees you a profit, rather than gambling your job and your company's life on an uncertain future price of gold which might well end up with you and your friends on the street if the price of gold were to tumble further. Hedging is all about risk reduction, and that's not a surprising reaction after a 30% downside move.
There may be other things going on besides mining company hedging, but I believe it is a reasonable explanation for the mild increase in the GLR.
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