When choked gold responds to hedging demand (and Soros)

Izabella Kaminska | Feb 20 19:58 | 13 comments | Share

Ay ay ay! Gold is approaching a death cross and all sorts of other commodities are looking nasty too.

So what gives?

We have two observations.

First, this whole thing about Soros selling GLD is making us sigh a bit. Headlines like“Soros dumps gold as prices sink” are not only misleading but missing the point entirely. What’s even more frustrating is that most of the time the Soros stories refer directly to the issue at hand: the sales date back to the fourth quarter of 2012.

These disclosures thus must not be taken at face value. This is, if anything, expert exploitation of the hedge fund disclosure system, based on the expectation that the filings themselves cause people to react too late rather than too soon.

Anyone who has access to a data terminal, however, can tell you what’s really going on. Soros Fund Management has been using GLD as a market mis-signalling vehicle.

Note the following chart. It shows the gold spot price above and GLD assets under management below (we’ve highlighted the critical Soros points):

You needn’t be a rocket scientist to spot the obvious trend.

GLD additions in the third quarter of 2012 very likely influenced a rise in the price of spot gold. Those additions were were very likely Soros’s 1.32m shares. Gold then peaked around the beginning of October, but it wasn’t until November that the Soros “buying” filing was released. This disclosure helped gold recover somewhat. But only a little bit.

Yet notice what was going on in the meantime on the GLD asset front.

We now know that Soros cut that position almost by half in the fourth quarter and that out of the original 1.32m, the fund retains only 600,000 shares. And yet in the time period in question, GLD assets actually went up slightly. They certainly did not move down.

The most logical explanation: while everyone was responding to the “Soros buying” news with err… GLD purchases, the Soros fund itself was selling into the buying momentum, and in so doing getting a better price than it could ever otherwise hope to achieve. The overall effect was one where GLD assets under management stayed neutral.

Simply speaking, the filing itself stimulated a false demand, which the fund happily took advantage of. A classic trading play, beautifully executed, if nothing else.

The fund was essentially happy for the original GLD purchase to have a market impact because it knew that by the time the purchase was disclosed an excellent exit point would be provided.

In short, this was more likely nothing more than expert exploitation of the filing and GLD asset management disclosure.

Which leads us to our second observation.

Where does this leave the gold market now?

As we know, Soros is left holding 600m shares. First thing is to consider: why?

The obvious answer is that the fund still believes there’s upside potential for gold.

We, however, are more cynical minded. It might be that the fund wasn’t able to liquidate the entire position profitably in time but has done so by now. Alternatively, perhaps the fund took the opportunity in the fourth quarter, or even earlier this year, to fully hedge that remaining share with commodity derivatives — positions which would never be publicly discernible. If that is the case, there’s no reason why the fund isn’t already profiting from the sell filing disclosure impact.

The truth is there are masses of possibilities and we will never truly know until the next filing date.

The point we’re trying to make is that none of these hedge fund filings should ever really be taken at face value. These funds have “hedge” in their name for a reason. At best, what we see are just small parts of extremely smart trading plays, many of which specifically exploit expected market behavior patterns related to communications and disclosure. At worst they’re one part of a cleverly hedged position. To run a fully-exposed market long position would be market suicide.

From a spot price point of view, meanwhile, until gold falls through $1,530-ish, there’s still a good chance it will return to its recent range bound trading pattern:

That said, it’s also true that by now anyone who was ever going to take an unhedged long position in gold has probably done so. That means by the time we get to $1,530 (if we do) there’s a good chance a sizeable chunk of the market will be tempted to take profits and that means liquidation.

The better the stock market performs and the more long-term yields rise, the greater the chances of that happening.

Meanwhile, one good place to look to when it comes to gauging just how spooky things are likely to get in gold, is the gold mining equity sector.

Remember, the big trend for gold-miners post crisis was the unwinding of their hedging programmes. This was, of course, intended to limit opportunity costs associated with further upside gains in the yellow metal.

The irony is that the diminished size of their hedging programmes now leaves them exposed to exactly the opposite trend: a fall in the price of gold.

Some miners, of course, did start re-hedging around 2011 — which was about the time the gold price started to flat-line and peak. And that pattern has notablycontinued in 2012.

But it’s unclear how easy those hedges will be to roll, or what sort of duration they are.

If you consider that gold really isn’t a consumption commodity but a “rebury it just as quickly as it’s produced” commodity, then you will appreciate that the key factor determining prices is how quickly new gold supply can be reburied and at what rate. Lacking that, how easily and affordably the sales can be hedged.

Now, if we presume all longs are already exhausted and that the price of gold has essentially been choked since 2011 (when hedging desire returned to the market) all yet-to-be produced gold supplies can now only be hedged at the cost of guess what, the spot price.

The more demand for hedging, the more likely the spot price is to fall, because no counterparty or bank in their right mind would provide such a hedge without an equivalent market short to balance it. Borrowing from central banks and selling into the spot market used to be the way to achieve that. But nowadays, it’s possibly much easier just to short via GLD instead.

Either way, at this point, the greater the demand for market hedges, the greater the physical shorting (or naked selling) is likely to be. And that means the greater the spot price correction.

For now, we’ll leave you with one last chart to keep you pondering, the GDX Gold miners ETF vs the S&P 500:

Something definitely seems to be happening.

Related links:
The end of RoRo, or is it? – FT Alphaville
Capping the gold price – FT Alphaville
What’s bugging gold? – FT Alphaville

This entry was posted by Izabella Kaminska on Wednesday February 20th, 2013 19:58. Tagged with GLD, Gold, Soros Fund Management.

 

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