The Gold Price Tide Has Turned!

We currently have record short gold positions (300k) on the COMEX, held by the commercials (read bullion banks), because they want to force gold and silver prices lower. As a result of the massive short positions, we are also witnessing record open interest positions, which tend to occur when there is a lot of interest in the underlying commodity futures. Open interest (also known as open contracts or open commitments short and long) refers to the total number outstanding of derivative contracts that have not been settled (offset by delivery). Open interest has been rising because the interest for higher prices for gold and silver has increased materially since the beginning of the year. Another indication for the increasing interest of investors for the precious metal futures is the degree to which the spread between the near month future and the next month future – currently August 2016 versus October 2016 – which has been widening and as can be seen in the chart below since 2012 it’s now at the highest level (-$4/oz).

Source: Paul MylChreest, ADM, Bloomberg

When this spread is negative, there is a cost for speculators to roll the current futures contract into the next one. Rolling from the August 2016 contract to October 2016 is costly at US $4.00/ oz., when the average has been closer to US$1.00/oz.

23-Year Chart: All-Time Record Commercial Short Positions In Gold

Source: ADM ISI, Bloomberg

The reason that they, the commercials (the bullion banks) have record short positions is because they try to counteract the increasing long interest from investors for gold and silver as the safe haven for failed monetary measures and currencies with continuously lower purchasing power (£/$1.50 before Brexit £/$1.30 after Brexit equal to a 20% decline!!). At present a contrarian movement is actually being made by the Yen with Japan basically the first country signaling that the stimulus measures don’t work any longer hence why the downward pressure can’t be sorted any longer. How many times can you cry wolf? And one of the major reasons that Japan’s currency is strengthening is that the country has a current account surplus like Switzerland! In fact Japan posted its largest monthly current account surplus in nine years in March 2016, empowered by an improved trade balance and strong returns from overseas investments. Japan's current account surplus expanded 6.9% on year to Y2.980 trillion, according to the Ministry of Finance. For clarity purposes the current account is the sum of the trade balance (exports less imports), net income from abroad and net current transfers; as the trade balance is generally the largest of these components, a current account surplus usually implies that the nation is a large exporter and has a positive trade balance. And a current account surplus increases a nation’s net assets by the amount of the surplus. And thus the current account surplus puts an upward pressure on the strength of the Yen. We have seen the same situation with the Swiss Franc.

With the stimulus measures failing to get the desired results, JGB’s were hammered again on Monday August 1 with the 10-yr yield rising 5.5 bps after the 8 bps jump on Friday July 29. At a yield of -0.135%, it is the least negative since June 9th. The biggest bond bubble of them all is in Japan, which is the first country showing us the result of failed monetary measures.

Next to that when the currency shows signs or probabilities of strengthening, the carry trade is being further adding to the strengthening trend. It should also be noted that the Japanese also tend to withdraw their funds from abroad when conditions at home seem to worsen despite the fact that their current account surplus has increased (less imports more exports). And last but not least, the Yen is also regarded as a safe haven currency for the US dollar. Consequently, it is why we see a strong correlation with the other safe haven: gold.

“Coincidently” the Japanese just bought a precious metal refinery in Switzerland! In July of this year Japan's Tanaka Holdings said it would buy Metalor Technologies International SA, a privately held Swiss precious metals refiner. The purchase of Metalor will allow Tanaka to expand into precious metals recovery and refining in Europe, North America and Asia. Another move by the Asians, next to the Chinese with the SGE (Shanghai Gold Exchange), towards the physical instead of the synthetic or paper gold and silver futures.

So far some central banks (amongst them the Fed, BIS, ECB, BoJ) and bullion banks have continuously and religiously been depressing the gold and silver prices in order to support the US dollar and its reserve status crucial for maintaining the “unlimited” financing of its defense forces and economic interests.

Though no currency can withstand a $4trn dilution without being backed up by productivity whilst keeping its purchasing power and keeping the gold and silver prices suppressed.  Remember in the end gold and silver are the mirror image, the reality check, of the true value of the US dollar. When the fundamentals of the US dollar and the US economy are sound there is no reason for the gold and silver price to be strong and visa versa.

The central banks and the bullion banks were able to manipulate the gold and silver prices down for such a long time due to the fact that gold and silver are also currencies enabling them to settle futures contracts using US dollars instead of having to deliver the physical gold and silver that are the subject of the futures contract. Gold and silver are the only commodities where this dual possibility for delivery, settlement or payment exists. Commercial buyers that need iron ore or corn need delivery of the underlying commodity because they need delivery of the commodity to carry out their ongoing business. Settlement in US dollars clearly wouldn’t suffice with industrial commodities. You can’t make steel or ethanol out of US dollars…as one needs the original feedstock.

It should be stressed that the inter-exchangeability of fiat currency (the US dollar) with physical gold and silver is the reason why the gold and silver registered inventories have been so small compared to the total number of futures contracts outstanding and daily (synthetic or paper) gold trades which in London is good for 5,500 tons daily whilst the daily worldwide mine production is only 9 tons or some 3,200 annually.

In other words there is a huge discrepancy between the real gold mine production and the synthetic or paper trading (mainly in order to sustain the current financial system and reserve currency) or a factor 600x. Well that is changing now because finally people begin to understand and realize that the measures of the central banks are not working. In fact they are having severe adverse effects…amongst them deflation, because the low interest costs have created massive economic inefficiencies or oversupply and the continuous undermining of the purchasing power of the currencies.

Policymakers have chosen to ignore the central issue of debt as they try to resuscitate activity with global central banks now printing $180 billion a month (and growing) "the global economy may now be trapped in a QE-forever cycle," confirming von Mises prescription that "there is no means of avoiding the final collapse..." The European Central Bank and Bank of Japan are buying around $180 billion of assets a month (see below), according to Deutsche Bank, a larger global total than at any point since 2009, even when the Federal Reserve's QE program was in full flow.

In fact as a result of the ultra low, zero or negative interest rates the debt levels have increased worldwide by some $70trn from $150trn in 2008 to $220trn to-date. Consequently, the debt/equity ratios have increased everywhere. At $220trn the Debt/GDP ratio is some 300% of 2016 global gross domestic product of $74trn, an increase of more than 20%. Over the past eight years, total debt growth has slowed but remains well above the corresponding rate of economic growth. It should be noted that if the average interest rate is 2%, then a 300% debt-to-GDP ratio means that the economy needs to grow at a nominal rate of 6% to cover interest. One can conclude that the ultra-low interest rates has resulted in much higher debt levels deteriorating the debt to GDP ratios and making it virtually impossible to grow itself out of this debt laden situation as demonstrated by the calculation her above even if the ratio would “only” be 150% or 100%. In other words there is no way out except for letting the markets run off the cliff. And then the people responsible for these irresponsible actions will either say we didn’t have the assistance of the politicians ordaining supporting fiscal policies or they will say we didn’t have any choice. This of course is horse #%@&$*, they only wanted to ensure that they could exercise their power with the ongoing rich remuneration as long as possible. Or these people are really ignorant and have never heard and understood mathematics responsibility and accountability. Ask the pensioners when not being able live of their pensions and when they find out that when this disaster in the making will have slashed their purchasing power (of the currencies) to a fraction of that what it was when they were contributing to their pension build up.

Considering the above mentioned one has to ask themselves, that is if your mandate allows it (because the mandate of many funds requires a minimum investment in government bonds and equities and they are therefore meant to lose all their profits when the markets implode, makes sense no!? I am of course facetious) where would you invest your money witnessing peak bond and equity valuations whilst the underlying earnings and economic circumstances keep on deteriorating? US earnings have been deteriorating now for four quarters in a row despite the nonsense that channels such as CNBC keep on reporting earnings compared to estimated earnings instead of comparisons with Y.O.Y. earnings and keep on reporting the creative accounting GAAP earnings for companies such as IBM and Microsoft to name a few instead that they report the real underlying earnings stripped for the buy-backs.

It is only because of the aggressive buying of the central banks (Fed, ECB, SNB, BoJ), trying to pretend that everything is honkey-dory for the reasons mentioned, that the US equity indices are showing new all-time highs. A "1 In 10,000 Year Event": JPM Head Quant Explains Why The S&P500 Refuses To Sell Off (http://www.zerohedge.com/news/2016-08-02/1-10000-year-event-jpm-head-quant-explains-why-sp-refuses-sell).  Most European and other indices showed historic highs in 2000, 2008 or in 2015 and are not able to achieve new record highs in 2016! See the chart below showing the highs and performance of the Euro Stoxx50 and the S&P500 index. The Euro Stoxx50 showed a record closing high of 5,464.43 on 6 March 2000. Whilst at present the Euro Stoxx50 is 2,990.76 34% below the 2007 peak of 4,557.57.At present the S&P500 hovers at historic peak levels of 2,173.60 +39% from its 2007 record intraday high of 1,565.26 on October 9, 2007. In other words Europe down 34% from 2007/2008 whilst the US is up 39%!?

Banking stocks plummeted on Monday August 1 as investors got their first chance to digest the results of the European Banking Association stress tests released after markets closed on Friday night and on Tuesday that plunge continued, with the STOXX Banking Index substantially in the red, and every single stock on the index lower.

At the close, the Europe-wide bank index was lower by more than 4.7%, suffering its worst one-day performance since the day after Britain voted to leave the EU.

Things were also particularly painful for both Credit Suisse and Deutsche Bank on Tuesday, who as well as seeing shares drop 5.9% and 4.8% respectively, had to contend with being kicked out of the Euro Stoxx50 index of blue-chip European companies because of how far their shares have fallen in recent months. Anyway from the charts below one can draw the conclusion that there is more downside that one can expect from Deutsche Bank and Banca Monte Dei Paschi. The Italian rescue operation has clearly not worked. Despite assurances from Italian prime minister Matteo Renzi that Monte dei Paschi's NPL problem is now over, investors clearly doubt just how viable the rescue plan — which will give a €5 billion capital injection to the bank and shift its entire portfolio of NPLs (worth roughly €28 billion) into a securitization vehicle — actually is.

Anyway the question is which safe havens are left when the mandated areas of especially investment bonds and equities start to decline? Gold and silver! And we have witnessed the first signs of outperformance with the XAU…so far having soared 138% since the beginning of the year with the XAU having risen only 10% since its inception in 1979. In other words we are only at the beginning of the resumption of this secular bull market. As mentioned finally investors are waking up to the insurance gold and silver represent…hence the strong investment in physical gold and silver the ETFs and options and futures contracts.

My point is the strong interest in the physical and other instruments by private investors and successful investors such as Soros, Druckenmiller and Icahn is frustrating the efforts by the central banks and bullion banks to depress the gold and silver prices.  And remember if you don’t own and physically possess the physical gold and silver, you don’t own anything because you hold a piece of paper that entitles you to gold or silver. It is called counter party risk, the risk that the party that has to deliver you the gold and silver can’t deliver. As we say in Dutch “you can't pluck feathers from a naked chicken”.

The more the central banks and the bullion banks are lowering the gold and silver prices the more buyers are coming out of the woodwork to snap up cheap physical gold and silver and are frustrating the manipulation of the central banks and the bullion banks. And thus we are heading for a guaranteed default of the COMEX and the LBMA. The default is unavoidable when investors prefer physical settlement instead of nominal (or US dollar) settlement, especially when the dollar starts tanking, with only 1 ounce of physical gold good for delivery in the COMEX registered inventories for every 100+ ounces of existing paper or so called synthetic futures contracts.

As we’ve shown numerous times, the commercials (read bullion banks) have a history of shorting into a rising gold price, waiting for speculator buying to exhaust itself in order to smash the price and cover. Subsequently, there were three occasions during the 2001-11 bull market when the commercials stopped increasing net short positions into a rising gold price because the demand for gold and silver was just too overwhelming. In all three instances gold went parabolic. Though now we could see a watershed moment with moves we have never seen before when the demand for physical gold and silver delivery far outstrips the available gold and silver registered inventories. The tide has clearly turned. Therefore, put on your safety belts and enjoy the ride!

August 3, 2016  © Gijsbert Groenewegen [email protected]