- The Fed's overnight repo auction was oversubscribed for the first time since the September 17, 2019 "repocalypse." A total $120B in liquidity was offered.
- One hour and 15 minutes after the close of that auction, the Fed announced a 50bp rate cut, which will require it to hand out even more repo liquidity.
- Combined open interest in gold on the COMEX continues to climb to new records, increasing the chances of a short squeeze on bullion banks.
- The recent selloff in gold only took 2 days to completely retrace.
- Conservative positions in UGL look tantalizing, but stay far away from leveraged mining funds.
By this time next year, I believe that gold is going to be above $2,000 an ounce, at least. From what I am seeing, the final blow-off top in the bond market is commencing. Gold is rising with it. The panic over coronavirus is shutting down the global economy, and even if this is only temporary, the weakest European banks are not in a situation to be able to handle it. When the first one falls, the bailouts and money printing will begin from central banks the world over, and gold will explode higher still. This is why I am long the ProShares Ultra Gold (UGL) as of market open March 5, and I advise my followers to be long this fund as well. Do not, however, go long leveraged mining funds like JNUG or NUGT or the triple leveraged gold fund (UGLD). These are too dangerous and cannot handle even short-term volatility. Below I explain this thesis in more detail.
March 3, 2020 was a crazy morning for me. As is my habit since the September 17th, 2019 “repocalypse” liquidity crisis that pushed overnight rights to 10%, I check the daily repo auction figures when they are published every morning on the New York Fed’s website. I found to my shock that the Federal Reserve provided more emergency liquidity on March 3 than it did even during the immediate aftermath of the September 17th repocalypse.
On March 3, a record $108.608 billion was submitted in overnight bids by repo market makers, $8.608 billion more than the Fed’s limit of $100 billion a day. That is the first time an overnight auction has been oversubscribed since the initial crisis. Plus, $70.95 billion in bids were submitted for the 14-day term repo limited to $20 billion, for a record grand total of $179.558 billion in bids and $120 billion in total liquidity injected. Records all around for both bids and accepted offers in a single day.
Source (Search for March 3, 2020 at the link.)
But that wasn’t even the craziest part. After I was done wowing over these incredible figures at 8:45am EST at the close of the second auction, I started wondering how much overnight liquidity the Fed was going to have to dish out every day in order to get rates down still another 50 basis points. Rumor had it that markets expected a 50 basis-point cut. I was expecting that 50bp cut to take place on March 18 during the next Federal Open Market Committee meeting, but then at 10:00am news crossed the wire that the Fed was giving the equity markets its fix immediately.
I then took a deep breath and said to myself, “Thar she blows!” in the spirit of the Australian whaling industry, of course. I guess we’ll see what happens in the repo markets over the next few weeks. It should be interesting, to say the very least. There could even be an additional cut on March 18.
For clarity, no, the emergency 50 basis-point cut did not apply to these March 3 morning repo auctions. The 50bp cut will only be implemented today, March 4. You can read the full Fed policy implementation note here for the full details.
Gold, meanwhile, suddenly recovered pretty much all of its losses since its huge one-day selloff on Friday, thanks in part to this emergency rate cut. Recovery in the gold market took all of two days. I thought the recovery in gold would be quick and I detail why in my last article. I said:
…[J]udging from the long-term chart of gold priced in real assets, gold may very well not be about to fall in dollar terms for much longer. Rather, commodities are more likely about to get more expensive, causing the gold/commodity ratio to fall sharply from record highs from the commodity side.
We’ll see if it holds, but still I wasn’t expecting it to be this quick. Gold stocks, however, are still wishy-washy and looking like they want to sell off at any excuse, so I will not be going long any leveraged mining ETFs. Leveraged gold proper however, is a different story. Here’s why.
Open Interest Continues Record Climb, Short Squeeze Update
In another previous article published February 18, I noted the possibility of a short squeeze in the gold market. My thesis was that record combined open interest figures have not fallen significantly since May 2019, so bullion banks had a record amount of contracts to either cover or rollover. The call to action of that piece was to go long leveraged gold (UGL) and miners (NUGT) (JNUG) if and only if gold prices failed to fall significantly during the next retreat in open interest on the COMEX. The miners are too volatile now for any leveraged positioning, but leveraged gold is another matter. On that note, let’s take a look at open interest on the COMEX.
The weekly figures encompassing the recent selloff and rally in gold have not been uploaded to the YCharts database yet, but we can look at the daily figures since February 26 on the COMEX directly, which include these most recent gyrations in the gold market. The site only goes back one week for nonsubscribers, being February 26, but the data currently available also includes the change from the day before, so we can plug in the gap of February 25 for a smooth count from the highs achieved February 24.
One caveat is that the COMEX website has a different tally system for combined open interest than the data pulled from YCharts and I haven’t been able to figure out how exactly to account for the differences between the YCharts data and that on the COMEX website itself. Whatever the discrepancy, keep in mind that what is important here is the trend rather than the absolute numbers. On that note, the last data point that YCharts has available on its chart is for February 24, when gold hit a high of $1,690, with open interest for all intents and purposes at all-time highs. We can therefore assume that the COMEX figures for February 24 are also basically all-time highs on its own tally system.
Now, combining futures open interest with options open interest manually on the COMEX website, here are the numbers we have starting with February 25. (Reminder: The difference between futures and options is that futures obligate both buyer and seller, whereas options only obligate the seller. Both types represent 100 ounces of deliverable gold per contract.)
Futures Open Interest
Options Open Interest
Combined Open Interest
So we see from here that following presumably record combined open interest on the 24th, the figure has only risen further since then. True, the big gold selloff on the 28th did register a sharp fall in futures open interest of about 47,000 contracts, but options traders ravenously bought the dip and snapped up over 120,000 net contracts to compensate.
Judging by these numbers, if a short squeeze is coming, then it just got a bit closer. True, I did theorize that perhaps a dip in open interest would not lead to a significant dip in the gold price, and that this would be my signal to take on leverage. However, what appears to be happening now is the inverse of this. Namely, the gold price did drop significantly, but combined open interest just kept climbing
Gold Short Squeeze Indications In The Repo Market?
Taking this back full swing, I also made the point in that previous short squeeze article that one possible sign of an imminent squeeze could be oversubscriptions in the repo market as bullion banks would theoretically need more reserves to cover or rollover contracts. We definitely saw massive oversubscription in the repo markets yesterday, particularly in the 14-day term repo offering, oversubscribed by a massive record $51 billion. So we can put a check mark there as well.
At this point, despite the evidence, I am still uncomfortable taking any positions in leveraged mining funds, as the selloff of February 28th has proven that they are just too dangerous and unpredictable. A single-day selloff like the one we just saw could completely ruin the trade and isn’t worth the risk. A developing short squeeze could still take some time, perhaps months, and the volatility of these funds is just too high to stomach in the meantime.
However, the ProShares Ultra Gold (UGL) fund looks much more reasonable and has already gained back its losses from Friday’s selloff. On a longer-term basis, the ETF is basically even since May 2013, the SPDR Gold Trust (GLD) being up 15% over the same time frame. That, I could hold on to longer term without having a heart attack on a sudden lurch on any given day.
Time To Lever Up
Given what I’m seeing on the COMEX, the repo markets, the Fed’s emergency (some might say panic) rate cut on March 3, coronavirus developments, and Treasury yields in deeply and increasingly negative territory in real terms and perhaps even nominal terms shortly, an allocation in UGL looks like a really good play right now. I will be establishing initial positions this week and scaling in further on any dips throughout the month.
I must mention the only major risk that I see in this strategy. It is that in any initial panic to cash, gold could sell-off again, perhaps sharply like it did on February 28, or worse, like it did in the initial stages of the 2008 financial crisis. This is why I advise against leveraged mining ETFs or even the triple leveraged gold fund (UGLD). For ProShares Ultra Gold though which is only 2x leveraged, even if this initial selloff happens, I believe it will be ephemeral and holders should be able to stomach it.
This is also why I advise scaling into UGL over the next 3 months rather than buying a full position now. If there is a selloff in gold in a panic to cash, then that would be the time to add to positions in this ETF. Once the Fed responds to any crisis with monetary stimulus, gold should take off to new all-time highs and beyond.
That said, I don't think investors should be worried about chasing here. Initial positions in UGL should be established now, with an intent to add on any significant pullback.
This article was written by
I invest in the light of Austrian Business Cycle Theory and cover monetary trends for the purpose of timing the credit cycle. My marketplace service The End Game Investor helps subscribers manage the risks of, and profit from the ongoing fiscal and monetary crisis precipitated by the COVID-19 pandemic. I use gold, silver, and associated stocks and investment vehicles in a low-risk high-return setup.
Analyst’s Disclosure: I am/we are long GLD, UGL. 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.
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