On the 14th of July, 2015, the US Commodity Futures Trading Commission (CFTC) published its weekly Commitment of Traders (COT) report. Over the next eight trading sessions, gold prices, which were already in a downtrend for almost four years, flushed down hard to fresh five-year lows. What was in that report that caused this mayhem? More importantly, why are gold bugs loving the same report and claiming that gold prices have bottomed out?
Shakti Shankar Patra | September 2015 Issue | The Dollar Business
Remember the Volkswagen short-squeeze episode? Just to remind you, it was October, 2008. There was a bloodbath in global stock markets. But suddenly out of almost nowhere, Volkswagen shares exploded 5x in just two days! Why? Before the entire episode, Porsche used to have a 31% stake in Volkswagen, while the German state of Lower Saxony held a 20% stake. Neither had Porsche any intention to buy stake from Lower Saxony, nor did the latter have any reason to sell out. But on the 26th of October, 2008, Porsche announced that it had increased its stake in Volkswagen to 43% and had another 31% in call options. With another 20% held by the government, this, meant that the free-float in Volkswagen, technically, was just 6%. The trouble, though, was that the short interest in the stock was 13%! What ensued hence, was a mad scramble by short-sellers to cover their positions, which saw the 5x move and actually, made Volkswagen the world’s most valuable company for a brief period.
Natural buyers
The reason for giving the Volkswagen short-squeeze example in an article about gold is simple. Something similar, although not as dramatic, might be brewing in gold. For, according to the US Commodity Futures Trading Commission (CFTC), non-commercial traders – hedge funds, individuals and financial institutions – are net short in gold futures for the first time since the agency started publishing its COT report in 2006. More importantly, this net short position is more a function of the creation of new shorts than the liquidation of existing longs. In fact, in another first, noncommercial traders’ outstanding short position in gold crossed the 1,00,000 contract mark in the week preceding 14th of July and has since, stayed above it.
That non-commercial traders were the most net long in gold futures in August 2011, around the time the precious metal was topping out means they are nothing but the best contrarian indicator. And although they might keep piling on shorts for some more time, thereby putting pressure on prices, it would just be akin giving more cannon fodder to the next gold rally. “What’ll propel the rally in gold even more is short covering, because you have lot more shorts in gold than what you normally see in the market. I can also foresee some kind of an event because I know there’s a shortage now manifesting itself in the physical market. I can experience that in my own precious metals business. I can see that in our suppliers and customers. Given that environment, I wouldn’t be surprised to see some of the physical buyers moving into the futures market with the intention of taking delivery. And delivery will be impossible, since there’s just no physical gold to deliver. Short sellers are counting on buyers not seeking to take delivery. So, there could be a serious short squeeze in gold sometime very soon,” Peter Schiff, Founding Chairman, Euro Pacific Bank, and one of the biggest advocates of investing in gold, tells The Dollar Business.
Fade the fed?
It’s no secret that commodity prices, generally, are inversely related to the US dollar. For, they are priced in dollar in the international market. And this inverse correlation with the US dollar has also played a big role in the continuation of the downtrend in gold in the last few months. For, convinced that the US Federal Reserve will finally hike interest rates in the United States from near zero this September, the dollar has been on a tear, with the Dollar Index appreciating over 20% in the last one year. So, by far, the biggest trigger for the start of a sustainable rally in gold could be the Fed having cold feet and delaying the proposed rate hike. But what’s the likelihood of that? “During their discussion of economic conditions and monetary policy, participants mentioned a number of considerations associated with the timing and pace of policy normalisation. Most judged that the conditions for policy firming had not yet been achieved, but they noted that conditions were approaching that point,” minutes of the Federal Open Market Committee (FOMC) meeting on 28th and 29th July, which were released on the 19th of August, read. If even after half-a-decade of near zero interest rates and unemployment rate halving since its post-GFC double-digit highs, FOMC members think the time to hike interest rate by even 25 bps “had not yet been achieved”, the likelihood of a sustained hike in interest rates is next to nothing, isn’t it? “I think the Fed is not likely to increase interest rates, but might just go for a symbolic hike. They might just increase Fed Funds Rate to 25 bps and I think that won’t affect the market much because it’s been discounted,” Marc Faber, Editor and Publisher of the popular Gloom, Boom & Doom report, tells The Dollar Business.
Who’ll call the bluff?
After six years of staying mum, China recently reported that its gold reserves stood at 1,658 MT at the end of June, 2015 – 57% higher since last reported in 2009. India’s gold imports, too, recovered from a two-year downtrend in FY2015 and are looking up so far this year. As discussed, short positions in gold are at an all-time high. All that the market is probably waiting for is someone to call the bluff of the Fed. If that happens, watch out for another Volkswagen.
Marc Faber, Editor and Publisher, Gloom, boom & Doom Report
“There could be a serious short squeeze in gold sometime very soon” - Peter Schiff, Founder Chairman, Euro Pacific Bank Ltd.
The Dollar Business caught up with Peter Schiff on the 7th of August, a couple of hours after the US BLS released the July jobs report, which had made him even more confident of a rally in gold.
Peter Schiff, Founder Chairman, Euro Pacific Bank Ltd.TDB: Since gold prices have hit a five-year low and have been in a consistent downtrend for the last four years, where do you think they are headed in the near term? Where do you stand on your view that the Fed’s proposed rate hike in September is nothing but a bluff and once the market sees it, the US dollar will head lower and gold prices higher?
Peter Schiff (PS): Gold is actually up a little bit today and that’s very interesting. For, everyone is now convinced that the Fed will hike interest rates in September, since today’s jobs report was not a disaster. It was just similar to what is being reported for a long time. But the question is if the Fed, as it says, wants to see further improvement in the labour market before hiking interest rates (and I don’t think the data that came out today constitutes further improvement) – how can it hike rate based on this data? If it didn’t hike rates six months back, what is there in this data that suggests hiking rates in September?
Everyone believes that the Fed is going to raise rates by a little bit. Even if they do, I think the US dollar has already priced that in. Maybe that’s why it is down today. What’s not down, though, is stocks, but they’ve been selling off for the last few months and the Dow Jones Industrial Average is almost down 6% from its highs. So, if they keep selling off, we’ll be soon in a bear market, which would mean the Fed won’t raise rates, since it doesn’t want a bear market in stocks. In the last 10 years, every time stocks have lost about 10%, the Fed has come out and promised more QE. But they can’t talk about more QE unless they take rate hikes totally off the table.
I still think it’s not impossible for the Fed to raise rates a little bit. But it’s never going to get them to, say 2%. It might raise them to 25 bps or 50 bps, but then it will have to go right back to zero because the US economy would go back to a recession. Janet Yellen’s plan to normalise the Fed’s Balance Sheet by bringing it down from $4.5 trillion to under $1 trillion is impossible. That just can’t be done. On the contrary, I think the Balance Sheet is going to balloon, to something like $10 trillion.
TDB: Would you say the real trigger for a major rally in gold is a slump in the dollar, once the Fed’s bluff is called?
MF: That’ll definitely be the main catalyst. What has hurt gold is the perception that the dollar will be strong and that interest rates will continue to rise. I think there’s also a perception that the initial rise in gold prices, before they peaked in 2011, was a bubble.
A few years back, guys like me became very popular, since we called the GFC. Those days, I used to recommend buying gold and talk about high inflation and people realised that I made sense. The idea that all this money printing by centrals banks will lead to high inflation and a crash in the US dollar got me a lot of credibility. But since that hasn’t happened, the same people now think that there’s no reason to buy gold. They think the Fed can print all the money it wants but that will never lead to inflation. Once people figure out that that’s wrong, once they realise that the dollar is indeed headed lower and that there’s high inflation, gold will have a lot of catching up to do. And I do think that when gold turns around, it’s going to do that with some vengeance.
What’ll propel the rally in gold even more is short covering, because you have lot more shorts in gold than what you normally see in the market. I can also foresee some kind of an event because I know there’s a shortage now manifesting itself in the physical market. I can experience that in my own precious metals business. I can see that in our suppliers and customers. Given that environment, I wouldn’t be surprised to see some of the physical buyers moving into the futures market with the intention of taking delivery. And delivery will be impossible, since there’s just no physical gold to deliver. Short sellers are counting on buyers not seeking to take delivery. So, there could be a serious short squeeze in gold sometime very soon.
TDB: Do you think a big increase in supply, which played an important role in the crash in crude oil prices, is possible in case of gold?
MF: I don’t see the likelihood of that, because a lot of the big increases in supply in the past came from new discoveries. And there aren’t going to be any, because none is looking for gold. In fact, most people can’t even mine the gold they have already discovered. They are not going to spend money to look for more gold. So, I don’t see any increase in supply, unless gold prices come up. Eventually, though, I do think that money will be spent on exploration and that there will be new discoveries. But that’s years away. Gold prices would have to be well north of $2,000/oz before any major company starts exploration projects.
TDB: Although India’s gold imports rebounded in FY2015 after a two year downtrend and have continued to rise so far this year, there’s a feeling in some sections that the country’s gold demand is finally falling. What’s your take on this?
MF: I don’t think Indian demand for gold is falling. For, although gold prices in US dollar have been weak, they haven’t been very weak in rupee terms. And anyway, Indians are much better off with gold than with the rupee. I think the demand for gold in India is only going to increase and that’ll start to happen once we breakout of this down cycle and people start seeing faster appreciation.
TDB: In the long run, you actually believe the world will go back to a Gold Standard, don’t you?
MF: I do believe that. I believe fiat paper money is the exception, not the rule. Over the last many centuries, many nations have experimented with paper money, but they have always gone back to gold. Gold has been the constant. It is the rule, not the exception. Fiat money is an experiment that I am sure will fail, because it has never succeeded.
One of the reasons for me being very confident of a return to Gold Standard is because it’s so much easier in the electronic age to adopt it. For example, my bank – Euro Pacific Bank – has a product, wherein you can access your gold deposits with a debit card. So, if you go to a store and spend, say, $1,000 using my card, $1,000 worth of gold will be liquidated from your account. It’s my answer to people who say gold is not money because you can’t carry it around. Well, now you can.
TDB: In the short run, other than the rally in the US dollar failing, what else could be a game changer for gold?
MF: Anything can trigger a big rally in gold, particularly since it has been going down for almost four years. It could just be something like short covering or bottom picking. Nothing goes down in a straight line, isn’t it? But according to me, the real game changer for gold will be the acceptance of the fact that the US economy hasn’t really recovered, that any meaningful increase in interest rates is impossible and that the Fed is going to do QE IV. Period!
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