Are Precious Metals Futures Heading for a Crisis?

I thought I had a good idea what disasters we might face in 2013, and then I saw the most recent US Commodity Futures Trading Commission’s Bank Participation Report for gold and silver. On the basis of recent BPRs these markets are heading for a crisis, which is generally unexpected. I shall break the reader in gently by looking at gold first. 

The first chart below shows US banks’ net short exposure to gold up to Dec. 4. Between February and August the US banks managed to reduce their net shorts from 104,717 to 57,689 contracts against a background of a declining gold price. This is logical, to be expected and sensible position management. However, when the gold price turned up after the August BPR, net shorts rapidly rose to new highs, and over the last month unexpectedly increased again while the gold price actually declined. This is a sign that the US banks, of which only five made returns for December, are having difficulty keeping a lid on the market that emotionally at best is neutral, but most probably somewhat oversold. This differs from an over-bought market with potential profit-takers to shake out, as was the case when gold traded at $1,900 per ounce and the same banks were able to bring the gold price back under control. 

 

The next chart is of non-US banks’ net shorts, which tells a very different story. From October 2011 these banks increased their short positions, with a sudden jump between August and October, before sharply reducing their net positions to 44,707 contracts this month. It appears that some of the shorts have ended up on the US banks’ books, pushing their shorts to uncomfortable levels as shown in the first chart. 

 

The jump in these net shorts between August and October was comprised of sharp rises in both longs and shorts involving swap dealers and the other commercials. Longs more than tripled from 9,199 to 34,881 and shorts rose even more from 49,772 to 113,445 on a rising gold price. The likely explanation is that buyers materialized through some of these non-US banks, which hedged by buying futures contracts. A dealer or dealers at one or more other non-US banks saw the price go against their shorts and tried to kill it by massive intervention. Subsequently, when the US banks sold the market down from the October rally these non-US banks took the opportunity to reduce their shorts to more normal levels. 

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