The run to all-time highs in gold is getting very close now, measured in weeks. Gold futures, the fall of a major bullion bank, and very bullish price action in the gold mining sector all point to an imminent upside jolt in gold prices up to, and perhaps even past, records in dollars. Gold is already comfortably past all-time highs in Swiss francs, euros, yen, Chinese renminbi, and pounds. The only laggard is the US dollar. The chart below show gold priced on different currencies since the September 2011 highs.
Data by YCharts
Gold has been in a gentle correction since April 14 when it hit highs of $1,790, but I don't think this will last for much longer. I expect the next move up to take gold up to and perhaps past all-time highs at $1,923. Here are my reasons.
Bullish action in gold stocks
Since capitulation in gold mining stocks in mid-March, the space has exploded higher by nearly 70%. This by itself isn't all that surprising or indicative of an imminent move in gold because miners were extremely oversold back then and a bounce was to be expected. Some mining stocks fell back very close to bear market bottom lows hit in December 2015 while gold itself went nowhere near its lows at all. What is more indicative of an imminent move is that despite gold's minor correction since April 14 (see chart below), gold stocks have continued trading higher by nearly 10%.
Mining stocks tend to predict moves in the underlying metal, and this time will likely be no different.
Record Collapse in Open Interest Fails to Dent Gold
When open interest contracts on the COMEX, the gold price tends to fall with it. Bullion banks, which sell gold futures fractionally backed by physical gold, buy these contracts back at a profit as the gold price falls, which causes the concurrent contraction in open interest. Here are a few charts that show this clearly. I have shown these before but it bears repeating.
First, open interest and gold prices during the April-October 2008 correction that we could technically call a bear market since it was a correction of over 20%.
Open interest in blue fell about the same amount as the gold price. Same thing for the decline that began October 2012 to June 2013.
The last gold bull market began in December 2015. The first leg higher was very powerful and lasted until mid-July 2016. The correction after also came with a fall in open interest, but gold resisted the magnitude of that open interest fall, as you can see below. This was a bullish sign and suggested bear market bottom was in, as I have pointed out before.
But this is nothing compared to what's happening now. Check this out:
Year to date, open interest in gold futures has collapsed by 37%, similar to other falls that have been accompanied by a fall in the gold price. But instead of falling, the gold price has actually risen by over 13%. Something like this has happened once before, and that was in 2011 leading up to gold's final blow-off in September:
Except this time, instead of a mild fall in open interest of about 16%, open interest has collapsed from record highs and gold just keeps chugging higher. Why the record collapse in open interest? A possible answer:
Bullion Bank Market Maker Folds
The Bank of Nova Scotia (BNS) is listed as one of 12 market-making members of 143 total of the London Bullion Market Association. No longer. The bank is closing its metals trading desk, shutting it down entirely. Not selling it or otherwise offloading it, just simply ending it. It will be very interesting to see the bank's next earnings report on May 26 to see how much losses it suffered in the gold futures market this quarter. Something tells me the losses will be quite large. Otherwise, the bank wouldn't be scrapping the entire operation without getting a penny for it.
Scotiabank isn't just any bullion bank either. It's a market maker. Since bullion banks increase the supply of gold futures contracts, this means that the supply of contracts will be lower than otherwise now. That should increase the paper price of gold. In order to induce one of the remaining market makers to sell more contracts, bidders will have to offer more dollars now. Plus, if Scotiabank has failed in the gold futures market, then other market makers could soon follow.
Why a bullion bank failing should raise gold prices can be better understood by comparing it to dollar strength during a fiat banking crisis. Bullion banking, according to Moneyland, is defined as follows:
As with fiat currency banking, bullion banking is typically based on a fractional reserve system. In this system, book money (like precious metal account balances or gold certificates) is generated by private banks based on a much smaller amount of base money (physical bullion, in this case). Book money is generated by the issuing of non-allocated gold certificates, the provision of loans denominated by precious metals, and the creation of precious metal account balances."
When a fiat bank collapses, book money disappears as deposits are erased, while base money remains unaffected. The dollar tends to rise in value and prices fall. That's what we call deflation. So, when a bullion bank fails, the gold equivalent of book money (futures contracts or other paper gold derivatives) falls, and base money (actual gold) remains unaffected. That's gold deflation, and the gold price of goods in services should fall as a result, or conversely the gold dollar price should rise. In other words, the fractional reserve leverage ratio of paper to gold, falls, which is reflected in the fall in open interest. It could very well be that the collapse in open interest since February is due, at least partially, to Scotiabank winding down operations. Never before has there been such a massive fall in open interest, and the fact that a market maker bullion bank is closing up shop precisely now is probably no coincidence.
Gold (Enhanced Delivery) Futures
Take a click over to the Comex website and you'll find a brand new gold contract series called "Gold (Enhanced Delivery) Futures". The only difference is that these contracts are deliverable in one kilo bars, 100oz bars, or 400oz bars, as opposed to only 100oz available in New York. It's basically London helping out with the COMEX shortage by making their 400oz good delivery bars available for COMEX settlement. Right now Enhanced Delivery has an open interest of precisely one contract, so it's not exactly active yet. If we see though that it becomes active and prices rise above those for the regular contracts, that probably means that longs want delivery and aren't just speculating for profit. It would be extremely bullish for gold.
Conclusion
I already advised adding to gold leverage through ProShares Ultragold (UGL) back on March 6. Now is the time to add to those positions. Despite a deep correction in mid-March, the ETF is still up since then. There could always be a sudden short term selloff again, so don't go all in obviously and add another tranche on any significant pullback. Anyone who followed my call to buy gold stocks on March 17 can simply transfer some of those profits over to UGL without risking any additional capital.
I advised back then against leveraged mining stocks like (NUGT) or (JNUG) because they were too dangerous, and good thing, too, because they got hit very badly in the March selloff. But now, since those two ETFs have lowered their leverage from 3x to 2x, small short term speculative positions in (NUGT) or (JNUG) could pay off well here over the next two months or so. I wouldn't hold either for more than 2 months though, and I would only put in what I could afford to lose with those two. UGL though can be held long term here.
