ROSS NORMAN - Gold locked into a self-fuelling feedback loop ?

 Identifying where the gold buying is coming from is essential as not all buying is equal.  

In strong hands such as central banks with a multi-generational view, the rally is 'high quality' and unlikely to be reversed, but with weak hands such as short term speculators, the opposite may be true. Two opposite outcomes.

And we are pretty confident we know who is behind the move.

In the absence of the identity being known, many use the blank canvas to pitch their favourite culprit ... Chinese Gen Z buyers, BRICs nations de-dollarising, non-aligned central bank demand, algos … banks short-covering, the list is long... meanwhile the chatterati on Zerohedge point out real inflation rates, WW3, impending civil war in the US, the unsustainable US debt levels. In short ... it has given everyone an opportunity to showcase their pet grievance or concern.

For sure the move is counter-intuitive in that it flies in the face of many financial market indicators such as a firm dollar, rising treasury yields, the fear index (VIX) relatively subdued and also the cinderella metal, silver, being slow to authenticate the move as it normally might. So that gave us a clue.

Whatever the driver for the gold rally, there have been grounds for deep caution ... physical demand has absolutely cratered in the West ; we hear physical dealers have been selling surplus coin and bar stocks at a discount to spot to reduce their cost of carry, while US Mint sales of gold eagles in March 2024 is down 96% year on year, while Perth Mint coins and bars sales are down 80% year on year and near a half decade low ... similar numbers elsewhere across Europe and the US. Bullion is flowing to major refineries to be converted into 99.99% kilobars to look for a home in Asia. So that is a change in the flow, but not necessarily the quantum.

European and US financial institutions see it similarly - ETF gold holdings have eased 465 tonnes year to date or shed 15% of their total holdings ... even global Central Bank purchases have eased (although one can read much into one months figure), recording just 19 tonnes bought in February 2024 - that's just 14% of the monthly run rate of the recent record 2 years. Chinese demand is hot for sure, but this is partially compensated for by much weaker Indian demand. No matter - this is not our smoking gun.

We had thought that a sovereign state might be behind the move - perhaps in the OTC market - maybe a BRICs nation along the ongoing 'de-dollarisation story' but they tend to buy on the benchmark (or fix) and these purchases are not. Further, we do hear the flow of gold to Asia is currently "good but not exceptional" ... and therefore not sufficient to propel gold to current levels.

For a move of this scale we would have expected physical transfer amounting to several hundred tonnes - and there is no evidence of that. And the LBMA vault data published today indicates no drawdowns - in fact loco London gold holdings rose in March marginally. So that draws a line under that.

So we know the buying is large, seemingly oblivious to either market signals and fundamentals and it is high conviction. And it is likely not a central bank.

The second possibility is momentum following algos chasing their own tail in a self-fuelling lunacy ... and again oblivious to fundamentals ... maybe but probably not.

And then there is a third possibility.

The options market.

There have been some large-ish trades reported by CME for call options with strikes at 2300, 2350 and 2500. But again not really sufficient to drive the market much higher.

By a process of elimination, that just leaves the OTC options market ... and that seems to have been corroborated today by the LBMA data. Someone has evidently made a monumental bet on the gold market via the OTC options market. The broad rationale for using the OTC options market is clear ... it is sufficiently liquid yet not entirely opaque. This really has been a stealth rally and the economic equivalent to muddy footprints across the floor have been hard to discern.

It appears a counterparty has taken a particulalry large bet on gold and squeezing the market ... arguably sufficiently large that it could even generate a self-fulfilling outcome. As the bullion banks grant calls at strikes above the market, they will purchase gold to delta hedge themselves as they are short gamma. As the price rises, they buy more ... creating a feedback loop. Nice.

But the devil is in the detail which, because it is the OTC market, is scant. We don't know the precise volumes, strike prices and expiry dates ... all we know is it appears to be extremely significant in size.

And they would be very much swimming with the tide in terms of the geopolitical and economic backdrop. A well known hedge fund did precisely this back in the early 2000's with enormous success.

Once the options expire the gold market will likely discover gravity. That is to say supply / demand fundamentals will prevail.

Meanwhile time is against the Fed ... they need to keep rates higher for longer to defeat inflation, but there is a mounting crisis in the US with many regional banks suffering and the commercial real estate sector in crisis. So the Fed also need to cut... and fast. And a rate cut traditionally signals double digit gains for gold.
The main take away is this move is a technical play or bet and when it expires as a squeeze like this does, the market will likely edge back to reality.

Currently the market is massively overbought technically and it is a long way from its traditional buyers. Is the new information bullish or bearish ... well that to a large extent depends upon the arcane world of options trading and where the main strikes are - but my reading is this is short term bullish but longer term bearish in the sense this does not pass as a 'high quality’ trade. That said, this has certainly put gold into a new orbit and will be giving it an entirely new gravitational pull.
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Ross Norman
MetalsDaily.com
ross@metalsdaily.com