2013-FEB-22

This week considerable instability developed in currency markets. The yield on US Treasuries has been rising, signalling that they may have bottomed out. And when it emerged from the FOMC minutes that some members are worrying about the commitment to buy Treasuries and mortgage securities while the British MPC were thinking of renewed QE, sterling had its biggest one-day fall for months.

Why does this matter for precious metals? It matters simply because there are some extreme positions in Comex futures. Volatility has picked up, with gold sliding $60 to a low of $1,554 mid-week and silver marked down to a low of $28.25.

Managed money (ie hedge funds) is short of 47,357 gold contracts, a record, and can be seen as the red line in the chart below. There are 45 funds short – well over twice the average and very close to the record of 48. Furthermore, their net long position (green line) is close to all-time lows.

Interestingly, the last time managed funds held record shorts was in May 2012, when gold bottomed out at $1,540 before rallying to the $1,800 October high. On that basis, managed funds in gold are as good a contrary indicator as you can get.

The bullion banks, which control prices in futures markets, are reducing their shorts and have cut their net short position in gold by 60,000 contracts – the lion’s share of the reduction being the counterpart of the managed money position. The Commitment of Traders report to be released tonight (UK time) will make fascinating reading, and it is a reasonable supposition that commercial longs have increased substantially while managed funds have gone even more short. The subsequent bear squeeze will be a wonder to behold.

Silver is a big problem for the bullion banks, as discussed in last week’s report. Since then open interest has increased further on price falls, suggesting the price is being muscled down despite resolute silver buying.

Managed money behaviour is different with silver, but bears further analysis. There are 16 shorts against a long-term average of 12, and there are 35 longs against a long-term average of 38. What this adds up to is that managed funds in silver are broadly cautious to neutral, so not so susceptible to emotional swings as in gold, which explains why the bullion banks are having difficulty closing their shorts.

The Week To Come

It looks like markets could become very volatile in coming weeks. On any rational basis, all markets are mispriced because of zero interest rates, and perhaps complacency will give way to fear. For gold bugs, this should ultimately be good after volatility in the short term.

Early Monday morning the UK’s Nationwide releases its house price index, which together with the BBA’s mortgage approvals will give a fair indication of overall sentiment. Reuters’ three-day summit on the future of the eurozone commences.

Tuesday sees the release of the US’s S&P/Case-Shiller Home Price Index, the Consumer Confidence Index, new homes sales, and Bernanke’s semi-annual testimony on monetary policy to the Senate Banking Committee, which continues on Wednesday.

On Wednesday we get the eurozone’s M3 money supply for Q4 2012 which is expected to have grown at 3.5%, and the eurozone’s Business Climate, Consumer, Economic and Industrial Sentiment Indices. US Durable Goods Orders and Pending Home Sales are also due.

Thursday is dominated by US news, which includes preliminary GDP, initial claims and the Chicago Purchasing Managers’ Index. And for yen-watchers, there is a raft of Japanese economic statistics overnight.

Friday brings us eurozone Manufacturing PMI and from the Bank of England, Mortgage Approvals, Net Consumer Credit and Secured Lending statistics, as well as M4 money supply. Finally, at 1.30 GMT (when the bullion banks might try to hit bullion prices ahead of the weekend) we get Core PCE Prices, Personal Income and Personal Spending statistics.

It should be an interesting week.