By Keith Weiner
The Earth is Still Round
Let's establish three facts up front. One, the volume of contracts traded was not "millions" (as at least one conspiracy theorist is claiming). During the one-minute window when the price of gold dropped from $1,254.10 to a low of $1,236.50 and recovered to $1,247, 18,031 August gold contracts traded. There was negligible volume in the October and December contracts.
Two, the Earth is round. This did not occur while "everyone" was sleeping (as at least one conspiracy theorist asserted). It happened when Europe was open and the UK had come online, at 9:01am British Summer Time (BST). China and Singapore were also open for business at that time.
Three, there was no single large futures trade that "smashed" the price, but a large number of smaller trades, with the largest trade being 296 contracts (close to 1 ton or $36 million notional). The chart below shows milliseconds (1/1000th of a second) from 9:01:00 to 9:01:30 - 30 seconds.
Trades in Comex August gold futures on June 26 just after the open of London trading, on a time scale of milliseconds. We would add the following caveats here: although this was chopped into many small trades, it is quite possible that the seller was a single entity (at least the seller of the bulk of the total contracts traded) - only there was no single buyer, but many smaller buyers, with larger bids only coming in after the price had already dropped quite a bit. We would concede that there exist fundamental reasons that might inspire a large sale, such as the recent rise in real interest rates (per our definition), or the upcoming release of the Fed minutes in light of the more "hawkish" tone the merry pranksters have lately employed. Also, as Keith demonstrates below, the tracks left by the gold basis indicate that physical traders joined in. All that said, there is one point brought up by some of the "conspiracy-minded" that deserves consideration: 1. The trade definitely did happen at a time when Comex trading volumes are normally a tiny fraction of what they were on this occasion, 2. when someone places such a large trade at this time of the day, it will raise eyebrows, because that is not the best way to get the best price - a few hours later, "normal" trading volume would very likely have absorbed a similar amount of selling without affecting prices quite as much, and 3. it happened just before a large options expiration, which provides a potential motive for not necessarily wanting to get the best price. To this one must keep in mind that open interest and trading volume in options on COMEX gold futures is absolutely humungous. Naturally, none of this is provable, and it may well not have been the motive behind the trade. It is not an unreasonable speculation though - after all, the gold fixing scandal has shown that short-term price manipulation is not beyond the capabilities of large traders, nor is their conscience necessarily an obstacle to such activities. However, the emphasis is definitely on "short term" - we do not believe that anyone is capable of altering medium- to long-term trends in this market, or in any other liquid market (as an aside: the way we see it, this type of "manipulation", if that's what it was, would not be illegal, contrary to the gold fixing shenanigans). [PT]
At this timescale, a lot of the trading is computer to computer, a fight between algorithms. We say fight, because the trading wasn't entirely one way. Some time slots show upticks in price. So what did happen?
We do not believe that one should try to look at whether spot or futures moved first to determine which one is the driver of a price move. The timing is very close due to high-speed fiber optic lines connecting market makers' servers. And errors in timing, especially of a third party observing from the outside, could be greater than the timing of the events being measured.
We have a better way to answer this question. If the price of spot is falling relative to futures, then we know there was selling of spot. If the price of futures is falling relative to spot, then we know there was selling of futures. This spread, future price - spot price, is called the basis.
Here is a chart of the gold price overlaid with the August gold basis, showing the London trading day (times are GMT, so the chart beginning at 7am is really 8am as the UK is on daylight savings right now). The crash occurred at 8:01AM GMT, which is 9:01 BST.
The movement in the gold price vs. the gold basis during the sell-off - this indicates that selling of metal in the spot market followed the lead of the futures market. Depending on how surprising the activity in the futures market was to dealers in bullion, bids and offers in the spot market may initially only have been adjusted without a lot of accompanying trading volume. However, the close tracking persisted as the day wore on. [PT]
We see a clear picture: as the price falls, so does the basis. This move was led by selling of futures. No, not a massive conspiracy. Indeed not massive at all.
And it should be noted that the basis did not move all that much - just 10 basis points. This suggests that though the move may have been driven by selling of futures, there was plenty of selling of metal too.
Of course, if people had bought a sufficient amount of metal to hold the spot price constant while some nefarious party sold futures, i.e., such that only the prices of futures would have gone down by $14, it would have resulted in backwardation of nearly $14 in the August contract. That would have been over 1%, or about 6% annualized.
Now let's look at the silver price along with the September silver basis, which behaved differently.
Silver price vs. the September silver basis (Note: While August is the most active contract in gold, September is most active in silver). This chart is quite instructive, as Keith points out below. [PT]
A 25-cent drop in price and a 15 basis points drop in the basis also seem moderate. Futures sold off a bit, but the selling was by no means exclusive to paper.
And then, look at the basis action an hour later. Someone - or many someones - was bidding up paper. Buying the dip. However, that had no impact on the price, so there was also selling of metal. An hour after the buying began, it subsided. But then it resumed.
And for the next five hours, we see sufficient buying of silver paper to push the basis above its starting point even though price peaked below the equivalent starting point and subsequently subsided another nickel.
This is what it looks like when exuberance in the futures market meets selling of physical metal. Especially from around 13:30 GMT.
We call 'em like we see 'em.
Charts by Monetary Metals
Chart captions by PT