Precious Metals: Massive Paper Selling Begets Unprecedented Physical Buying

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 |  Includes: GLD, PSLV, SLV
by: Tim Iacono

Massive selling of leveraged long futures positions in gold and silver markets on Monday sent prices tumbling after the first wave of selling on the Friday before as precious metals saw their steepest two-day decline in more than three decades. Over just these two trading days, the gold price fell more than 15 percent, while silver tumbled nearly 20 percent amid more talk of market manipulation as ETF investors continued to exit positions.

Lower futures market prices led to an unprecedented surge in physical buying, and mounting evidence of the disconnect between the price of physical gold and silver and the "paper" variety was clear to see in widespread shortages of bullion products and soaring premiums.

After a two-day plunge of almost $240 an ounce, the gold price rose $80 in recent days, but ended the week down 4.8 percent, falling from $1,477.00 an ounce to $1,406.50. Similarly, silver tumbled more than $5 an ounce but then clawed back about a quarter of that decline, ending 9.9 percent lower when the week was over, down from $25.85 an ounce to $23.29.

Spot gold is now down 16.0 percent for the year, some 26.9 percent below its all-time high from late-summer of 2011, and the silver price has tumbled 23.3 percent in 2013, a whopping 52.9 percent below its record high set almost exactly two years ago.

As shown below via StockCharts, the gold price plunged (red arrow) and trading volume surged (gray arrow) as margin calls from market action on Friday forced more traders to liquidate long positions on Monday morning and more stop positions were triggered.

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This pushed the gold price to levels last seen in early 2011 trading, just after the run-up that occurred in late 2010 and prior to the advance to record highs.

The nature of this decline has prompted new speculation as to its origin, and all signs point to market manipulation.

Sharps Pixley CEO Ross Norman said on Monday that 400 tonnes of gold were offered for sale early on Friday, April 12th in what "had the hallmarks of a concerted short sale."

Simply put, sellers exiting positions (and seeking to get the best price in the process) don't do this sort of thing, as they know prices will quickly plunge.

Whether this was one or more large hedge funds acting alone or in concert with investment banks, central banks, or branches of government will likely never be known, but it is hard to argue against this being market manipulation.

After stop-loss orders were triggered when technical levels were breached on Friday, margin calls resulted in forced selling on Monday, leading to a market decline that left many analysts speechless. Russell Rhoads of the CBOE Option Institute put the decline in perspective when he noted:

Friday was a 4.88 standard deviation move in the price of gold. For simplicity's sake let's call it a five standard deviation move. Statistically we get a five standard deviation move approximately once every 4,776 years. So we should not expect another move like this out of the price of gold until May 17, 6789. ... Currently the two-day price change in GLD is $16.65, which can be converted to just over eight standard deviations. I wanted to share what this comes to, but the table I use only goes up to seven standard deviations. Let's just say the sun is expected to burn out first.

Those more trusting in the idea that markets are operating "normally" point to a number of factors for the $200+ break in the gold price over the last 10 days. These include the failure of the metal to move higher after the announcement of the Federal Reserve's latest money printing effort in December, a surging U.S. stock market, an improving economic outlook that led many to believe that central bank money printing might end sooner than expected, and fears of central bank gold sales in Europe prompted by a proposed sale of Cyprus bullion holdings.

Yet all of those factors can't explain why, on the morning of Friday, April 12th, about 15 percent of annual global gold production was put up for sale.

The World Gold Council, a group that normally doesn't comment on market action, had this to say in a press release on Friday:

It has become increasingly clear over the course of the past week that the fall in the gold price was triggered by speculative traders operating in the futures markets. Their short-term view of generating a trading profit is in stark contrast to the views of long term investors in gold, as evidenced by the massive wave of physical gold buying that began over the weekend and accelerated following Monday's further decline. The surge in gold purchases is spanning markets from India and China to the US, Japan and Europe. Buyers are viewing this as an opportunity to purchase gold at prices not seen in the past couple of years.
...
Clearly the desire to own gold, as an investment and for adornment, has made itself felt in the physical market. Gold operates on the basic economic fundamentals of demand and supply. Our view is that demand is strong while supply remains constrained, and that this dynamic ultimately drives the long-term price of the metal.

It was reported late in the week that the CFTC (Commodity Futures Trading Commission) may investigate the sharp price declines, however, not much is likely to come of this, as groups such as the CFTC have proven to be largely inept at overseeing markets, reluctant to hold big Wall Street firms to account, part of what is widely seen as a very successful effort of "regulatory capture" by the industry.

An indication that a bottom may already be in for the gold price came when data from the CFTC through April 16th indicated that hedge funds and other speculators added to their net long positions by 10 percent. Open interest in gold surged by 24 percent in a change that surprised analysts.

Selling in gold ETFs continued as the SPDR Gold Shares ETF (NYSEARCA:GLD) shed another 36 tonnes of the metal after holdings declined by 47 tonnes the week prior. As detailed in Do More Gold ETF Outflows Mean Even Lower Gold Prices Ahead? last week, ETF flows are clearly a lagging indicator, and I'd expect metal to continue flowing out of the GLD trust for months after prices have made a long-lasting bottom.

As for silver, given the nearly 20 percent decline in the price over the last two weeks, holdings at the popular iShares Silver Trust ETF (NYSEARCA:SLV) have been remarkably steady, down just 47 tonnes or about 0.4 percent during that time. Due in large part to selling by the Sprott Foundation, the premium paid for the Sprott Physical Silver Trust (NYSEARCA:PSLV) recently dipped into negative territory, but ended the week at a scant 0.03 percent. Recall that this premium had soared to over 30 percent early last year, just a few months after the gold price reached its all-time high.

But it was the massive buying frenzy in physical markets that was perhaps the most important development in precious metals markets last week as people around the world responded to lower prices spurred by the sell-off in paper markets by buying gold and silver coins and bars in record amounts. When all is said and done, this could be the most significant development from last week, as it could bring to light how poorly futures market trading reflects the physical market supply/demand fundamentals, as noted in Paper Selling In The West Could Spur A Gold Rush In The East.

Following the confiscation of depositor savings in Cyprus and combined with unprecedented money printing by major central banks that show no signs of slowing, confidence in policy makers, the banking system, and the world's many paper currencies will ultimately decide whether the gold price goes higher or lower, regardless of what futures market traders do over the short term.

Put simply, recent buying of physical gold and silver is evidence that confidence is faltering.

The Indian gold market was the first to respond to lower prices last week, but this soon spread to other areas such as China, Dubai, Japan, the U.S., and elsewhere. Premiums have soared with coin shortages now widespread, and those silver coin dealers currently offering metal for sale (with a promised delivery of 4 to 8 weeks) now charge an average of about $5 an ounce above spot, as detailed in this item at the blog.

Here's just a sampling of some of the news accounts from last week on the surge in physical buying:

To be sure, paper selling by leveraged traders in futures markets that had all the hallmarks of market manipulation has resulted in an unprecedented physical buying frenzy as years of pent up demand for precious metals at higher prices has been unleashed.

The question now is whether this surge in retail demand and similar buying of the physical metal by emerging market central banks (that won't be reported for months, if not years in the case of China) will be enough to push prices higher in the "paper" markets.

Futures traders and portfolio managers have clearly soured on precious metals as an investment, but not the public.

This more than anything else is the best indication that the long-term bull market is far from over.

People were lined up at coin shops before the gold price surged to $850 an ounce in early 1980, not after it plunged from that level.

The weakness in precious metals markets since 2011 will probably be looked back upon someday in the same way that the brutal 1975-1976 gold market decline is now seen, as shown below via this item at U.S. Global Investors.

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Precious metals prices can undergo sustained corrections as part of an ongoing bull market, as evidenced by the 44 percent decline in the gold price almost 40 years ago.

Back then, gold had risen from $35 an ounce to nearly $200 an ounce in the years after the last ties between the U.S. dollar and gold were severed by President Nixon in 1971. The gold price then fell to as low as $103 an ounce in August of 1976 before rising to its inflation adjusted record high in early 1980, a level that translates to at least $2,400 an ounce today.

Big moves such as the six-fold increase from under $300 an ounce a decade ago to over $1,900 an ounce 19 months ago sometimes take time to digest, and that is likely what has been happening since gold and silver reached record highs (in nominal terms) in 2011.

The bad news here is that, based on the 1970s precedent, the current gold price correction might not yet be over.

Disclosure: I am long GLD, SLV, PSLV, and I also own gold and silver coins and bars. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.