Whoever whacked the gold market Tuesday night is either deviously cunning or a complete idiot. Whichever serves as the true explanation, gold has sustained significant technical / price momentum damage and lost the support of trend-following capital flows (which tally in the hundreds of billions).
A barrage of sell orders early Wednesday sent gold prices down 1.5%, their steepest decline in more than three weeks.
The selloff occurred in the first minute after the New York trading floor opened at 8.20 a.m. EST, the traditional start of the Comex trading day, dropping $25.40 an ounce to $1,710.30 from the session’s opening price of $1,735.70.
A wave of bearish options bets overnight weighed on sentiment, setting the stage for the decline. The drop in prices accelerated as automated sell orders kicked in, traders said.
Many traders had preprogrammed orders to sell gold futures at $1,730 an ounce, said Dave Meger, director of metals trading at Vision Financial Markets. Known as “sell stops,” these orders protect investors by automatically selling contracts once a price level is reached.
More than 13,000 contracts—4% of Tuesday’s entire volume—changed hands in the first minute of floor trading….
Gold traders received a strong negative signal from the options pits Tuesday evening, when around 20,000 protective put options were purchased to guard against gold falling below $1,700 a troy ounce in January. Traders purchase protective options to limit losses or protect gains in their existing positions.
The “deviously cunning” explanation comes in the form of a “Rothschild trade.”
As legend has it, the Rothschilds had an information edge back in the day via an extensive contact network and a fleet of carrier pigeons. When Nathan Rothschild heard word — before anyone else — of British victory at Waterloo, he reputedly walked into the exchange and began selling heavily. Other traders, seeing that a Rothschild was selling, scrambled to sell too.
But of course, in this version of the story, the Rothschild sales were a red herring — the Waterloo news was bullish. After the other traders had dumped shares, driving down the market, Rothschild began buying with magnificent size, at much better initial prices thanks to his headfake.
This possibility is reflected in the simple observation that slamming a block of 20,000 Jan puts into the gold market, on a random Tuesday night, is practically guaranteed to cause ugly dislocation. Were the responsible party actually planning to buy a lot more gold, as opposed to simply hedging current holdings, such a move would be brilliant, allowing for short-term lower prices and less risk of gunning the market with high volume buys.
That is the “deviously cunning” explanation. But there is also the “complete idiot” possibility…
Some massively large hedge fund shops have excellent trading operations. For a clear demonstration of this, check out Felix Salmon’s piece on SAC Capital and the Elan trade.
SAC’s traders were skillful enough to move an astonishingly large block of stock (relative to float and daily volume) without heavily disrupting the market. As Salmon writes:
for me there are two big-picture lessons here. The first is that SAC is an amazingly good trading shop; we probably already knew that. And the second is that any time you see a market reporter blaming “selling” for the fact that a stock went down, you can take that with a pinch of salt. Because the lesson here is that an absolutely enormous amount of very real selling can have a surprisingly small effect on a stock’s price.
But not every shop is run by super-astute traders. Some, in fact, are run by long-term buy-with-conviction types who seemingly couldn’t trade their way out of a paper bag (ahem, John Paulson, cough cough). Taking a massive position and sitting on it until external forces require you to do something drastic does not count as trading.
If someone like a Paulson, a shop with a massive long precious metals position, did indeed decide “we need to hedge against a bullish fiscal cliff outcome” — which would be bad for gold — and further thought, wrongly, that the market could absorb a huge hedge without too much disruption, then said party might well have decided to put it on all at once (or at least a very big chunk).
Either way, while silver has managed to recover the damage short-term, gold has not… and serious questions remain as to precious metal miners either way. One problem with gold stocks here, in spite of their impressive rebound from Wednesday’s drubbing, is the potential for a “heads you lose, tails you still lose’ fiscal cliff outcome:
- If the fiscal cliff resolves bullish, capital could shift into assets more conducive to economic optimism than precious metals.
- If the fiscal cliff resolves bearish, PM miners are at risk of “going down with the ship” along with all other risk assets in an indiscriminate sell-off.
The other factor made abundantly clear this week is the incredible treachery of the opening print. For weeks and weeks markets displayed the tendency of opening bullish, then selling off into the close… and recently that pattern has flipped, with bearish opens begetting script flips to the upside.
As the algos whittle down short-term HFT profits to almost nothing, like a frenzied circle of sharks eating each other, some rocket scientist somewhere is surely writing a program to exploit this enhanced script-flipping tendency. Higher timeframes maintain their integrity, though, by virtue of being much harder for the algos to game (with far less potential for millisecond profits); we have adjusted our own game accordingly.