As the saying goes, “even paranoids have enemies.” Regardless of whether the bizarre bear market in gold prices that began in 2011 was manipulated, it now seems undisputed that, once the momentum and “algo” traders twigged to it, it became the safest short of the decade.
Whether you favored pair trades (e.g., long the dollar, short gold) or simply outright naked shorts, gold was the place to be. The more you used the trade, the better it worked. No one really cared why or how. Taking gold to the woodshed for a sound beating had mysteriously became the most reliable trade of the period. (One pundit even referred to shorting gold as “a trade protected by low friends in high places.”)
Actions have consequences. The first and most obvious consequence was that the entire worldwide gold mining sector became roadkill. Again, no one questioned why or how an asset still in demand (China, Russia, India) could suddenly be priced below the net cost of production.
The shorts were making too much money to care and the longs were so traumatized as sentiment for the yellow metal dropped to lows never before seen that they preferred taking their losses and hiding under the bed compared to the prospect of opening risky new positions. (Source: “Fueling Gold’s 2016 Upleg – Adam Hamilton,” SafeHaven.com, December 31, 2015.)
Gold Prices Now at Critical Juncture
Which brings us to the present. Gold is lurching along into 2016 still carrying, as baggage, massive negative sentiment; over four full years of horrific returns and chart data; a monster overhanging short position left over from the “mo-mo boys” and hedge funds in 2015; negative to neutral prognostications from virtually all the mainstream banks and analysts; and ongoing daily carnage in the mining sector.
Just how bad off are the mines, you ask? The entire junior mining sector, normally the critical source of new future production, has been either hobbled beyond recognition or simply vaporized. The seniors have held on (barely) by passing their sustaining and shortfall costs to existing shareholders in the form of explosive share dilution (300% on average) and taking on massive amounts of new debt. (Source: “Gold Undervalued Due To Massive Stock Dilution & Debt,” Silver Doctors, January 6, 2016.)
To suggest that shares in the mining sector have become value picks because of all of this is beyond an understatement. Keith Neumeyer, who founded two individual billion-dollar companies (First Quantum Minerals [TSE:FM] and First Majestic Silver [NYSE:AG]), recently opined that he never expected to once again see the mining space so devastated that “gold in the ground” in many companies was being priced at $10.00 per ounce or less. (Source: “Incredible Signs of a Bottom in Gold,” Gold Silver Worlds, October 4, 2015.)
If the Gold Market Reverses, What Might the Trigger Be?
The question then becomes this: if gold is indeed to become the big long of 2016, what events or triggers do we need to first see to make that happen?
Sentiment, of course, tends to be a trailing indicator and will not reverse until the primary trend itself reverses. So that’s not the place to look. Ditto for the activities of the mo-mo crowd, where the passion for shorting gold has become almost indistinguishable from clinical addiction. They will not back off until their knee-jerk shorts are seen to cause them constant and never-ending pain. Nor can we simply sit back and wait for Comex or LBMA to default on delivery because, as is becoming increasingly clear, these semi-opaque exchanges seem to be de facto shadow-backed at the government level.
As Comex watcher Harvey Organ has explained many times in his daily blog, every time a default seems imminent, the sudden and mysterious appearance of new gold inventory, along with some very unorthodox last-minute accounting entries, rises up once again to save the day. (Source: “Again no gold enters the Comex,” Harvey Organ Blog, October 31, 2015.)
In the hit movie The Big Short, the script explains how Dr. Michael Burry painstakingly identified the pending refinancings for tens of thousands of floating-rate mortgages as the critical inflection point for his once-in-a-lifetime trade. Will a similar future event change gold’s fortunes?
The Answer? The SGE Yuan-Denominated Daily Gold Fix
I think the answer is, yes. I think the key event the yellow metal has been waiting for is the launch of the daily Shanghai Gold Exchange (SGE) yuan-denominated gold fix.
My reasoning is as follows:
- The SGE itself and, correspondingly, the upcoming SGE gold fix are both physical only. While Comex and LBMA seem to be moving one ounce of actual metal for every 300 pieces of paper, the ratio at the SGE is approximately—and always will be—1:1. (Source: “Paper Dilution Hits 294X As Comex Registered Gold Drops to All Time Low,” Zerohedge, November 30, 2015.)
Naked shorting from mysterious and invisible sources will no longer be a factor for the longs to deal with. East-West arbitrage will, in short shrift, make any shenanigans in the gold pits very painful for those western shorts who do not actually have the hard metal to back their poker hand, which, it seems, is most (if not all) of them.
As senior London gold trader Andrew Maguire recently remarked, “The Shanghai Gold Exchange Fix will be settled in Yuan and involve 15 Chinese banks, but also includes at least five of the same LBMA banks that rig the London Fix. But there is a major difference. These Fix prices will represent delivered physical bars without any paper market dilution and most importantly all participating banks will be heavily regulated and unable to spoof or paint the Fix as they do now.” (Source: “Developments in the Gold Market,” King World News, December 18, 2015.)
- Uncharacteristically, the Chinese have already been telegraphing that the SGE is a potential political football, a real game-changer. It was supposed to be launched in April 2015 amidst great fanfare, but it wasn’t. In mid-summer 2015, Reuters reported that a 30-day software shakedown had been undertaken by the Chinese and everything was working correctly—but still nothing. (Source: “SLG Gold News – Sharelynx,” Sharelynx.com, December 18, 2015.)
A Chinese spokesman next assured reporters that the gold fix would launch no later than December 2015 and yet it did not.
The most recent word is that the new date is April 2016. Since every single day the system is offline is costing serious money, what is the possible purpose of the delays? (Source: “Shanghai Gold Exchange Said to Delay Launch,” AAA Stocks, December 11, 2015.)
- Could these delays have something to do with the fact that many experts believe that China is using an accounting trick to dramatically understate its true gold holdings? The word is that the country is storing its gold in satellite and junior banks instead of its central bank and conveniently neglecting to tally it all up.
Could it be that at some future point, China will disclose its true holdings as the key, the cornerstone, for 100% yuan-denominated, gold-backed, trade on their showcase “Silk Road” across Eurasia? In the summer of 2015, the Russian news service Pravda did a story never really intended for Western eyes. It tallied China’s actual gold stores at over 30,000 tons, or some 20-times its officially stated number! Is this part of the larger puzzle? (Source: “China saves up 30,000 tons of gold,” Pravda Report, May 15, 2015.)
- Could another part of the puzzle be that the ABX, an upstart bullion exchange based out of Australia with agents already licensed in some 17 different countries worldwide, is planning to piggyback off the SGE gold fix and directly connect buyers and sellers of real (physical) gold bullion without the need to work through Comex and LBMA? If so, how would that affect the ability of Comex and LBMA to continue to set prices worldwide based almost entirely on paper shuffling? (Source: “ABX GLOBAL EXCHANGE,” Goldvu.com, last accessed January 1, 2016.)
- Even Descartes himself would have been keen to untangle this logic loop. The Chinese are not merely the largest gold producers in the world, but they are also the largest yearly importers. To phrase that differently, China has the largest number of producing gold mines of any country on the planet, which has been the case for some considerable time, yet 100% of the country’s production is immediately snagged by its own government for internal use.
That said, its “perceived deficit” (what they really want to have—what they already have) is so outrageously large that the country is, paradoxically, also the largest buyer of gold on the planet—for years. Against this backdrop, where the Chinese are arguably seen to be putting all their eggs into a single yellow basket, can we really think they are not somewhat annoyed at the ongoing antics of the Western bourses?
Just days ago, China warned the foreign bullion banks operating within its borders that if, for any reason, those bourses should decline to fully participate in the upcoming SGE gold fix or ignore China’s tough new rules for gold trading, the banks might forfeit their gold import quotas for the Chinese market.
Hearing this, one has to ask this question: is there even a chance, however small, that China is unaware of the influence the foreign, mainly paper, gold bourses have already had on the yellow metal and are in any way willing to allow this insanity to continue? The most likely answer: no! (Source: “Foreign banks in China warned,” Reuters, January 5, 2016.)
Again, Is Gold the Big Long for 2016?
My suggestion is that if any single factor could correlate (within the gold environment) to Dr. Burry’s carefully calculated inflection point for his legendary big trade, it would be the upcoming SGE gold fix.
I am not saying gold will rocket to the moon directly following the event. In fact, I think quite the opposite. In contrast to the highly aggressive Western approach to economic warfare, the Chinese are self-proclaimed gradualists. They prefer to solve problems slowly and over time.
What I am suggesting, however, is that anything that puts a definitive end to the perfect bear storm that gold is now caught in—and includes a return to legitimate gold price discovery that actually allows the mining sector to make a buck—would be worth watching very closely.
Very closely, indeed.