Both gold and silver experienced historic sell offs during the last few trading sessions. Although market commentary and analyst opinions have been varied, very few outside of the precious metals community have come close to discerning the reality of this move.
Without a working knowledge of price discovery, most people will fail to grasp the meaning of what just happened.
To begin with, the key is to always focus on the origin of this move. Where and how the selling originated is what matters most. Outside market forces and technical indicators may seem to fit and support the move, but remember that all commodity markets with pricing dominated by derivatives have now diverged from anything resembling a natural trading structure.
Here is What Happened
In the precious metals market, the usual dominant players consist of one or two large entities who maintain exaggerated and naked short positions. They dropped a huge selling bomb into the CME pits last Friday that got the sell-off ball rolling, and the price went down on huge trading volume as stops were triggered and new selling interest emerged. Subsequently, prices have now moved below just about every key moving average.
The latest move is largely a result of panic selling and follow through liquidation triggered by margin calls. Nevertheless, as many gold and silver investors know, these moves are initiated via electronic or high-frequency trading programs, and they have nothing to do with real supply and demand.
In fact, this type of computerized trading now dominates every electronic market, and by some accounts,it is responsible for upwards of 70 percent of all trading activity, including that seen in the equity markets.
Open interest in silver was at record levels for an unprecedented period of time. This was unusual because it occurred during a time when silver had been correcting generally lower after having reached a historic peak in 2011. Normally, open interest falls with prices as speculators sell out their positions.
The Impact of Hedge Funds
Things really ripened with the entrance of the hedge funds. These large speculators had become short the market in waves over the last few weeks for the first time in seven years in silver and in even longer for gold.
Typically, any hedge funds pile in on momentum. This often makes them the last to arrive on a move and the first to bolt and cover their positions.
As long time silver analyst Ted Butler pointed out on Monday, this move probably allowed the big silver shorts to cover the majority, if not all, of their trapped short positions. Obviously it is illegal and immoral to use big positions like this to influence price, but if this is indeed the case, then the market has just been cleansed of at least some of this very uneconomic position so that things could now be set up for a move upward of similar magnitude. The upcoming COT report will clarify this positional situation considerably.
The entire dramatic move down could be about that short-covering and nothing else. Obviously, this is about as far from how natural markets should operate as one could go.
Goldman Sachs’ Revised Forecast and the Cyprus Sale Rumor
Meanwhile, the mainstream financial press remained focused on Goldman Sachs's recent call for gold in the 1200's, the Cypriot "gold-selling rumor" perhaps justifying further gold liquidation from the rest of the EU periphery, and news that the FOMC’s minutes indicated the Fed may be stepping back from asset purchases later this yearas catalysts for this dramatic sell-off in the precious metals.
Nevertheless, Goldman Sachs is notorious for talking their book (or the reverse of it) in order to get their customers to do what they want and help them out of nasty positions.
Regarding the Cyprus reasoning, it would be quite a stretch to assume that any of that gold would ever reach the market, especially given the demonstrated record buying levels of the developing world's central banks that desperately need to build hard currency reserves of their own.
Of course, it seems as if the world forgot that the Cyprus template includedthe confiscation of bank accounts, which in addition to official policy and historic central bank balance sheet expansion via competitive currency devaluation, could be the most bullish reason for moving money out of the fiat currency system and into alternative hard assets like silver and gold that people have seen in modern times.
Behind the Scenes
Basically, speculation about this move outside of the actual trading mechanism is not useful. Furthermore, stepping back a little closer to the underlying positioning issue, one might ask whether the big shorts were actually being pressured or forced to make this move by the CFTC.
Perhaps an orchestrated move like this was the only way these bullion banks could get out from under these dangerous positions? The heterogeneous longs in silver had been standing strong and were a real threat to triggering a short covering panic. They presented a clear sign to the authorities and the concentrated shorts that the decades-long silver price manipulation could not go on forever.
Given how poor sentiment has been, and the general ignorance about what is happening in silver from a macro-economic perspective, it is not hard to envision the price of silver running through $100 very quickly and without even creating a U.S. Dollar panic. In fact, the Dollar could even remain "strong" given what is happening in Japan and Europe.
Of course, the mainstream media will be flashing this week's chart each and every time silver moves up in any significant way, proclaiming legitimate and fundamentally justifiable pricerises to be ‘just another bubble’ as they always have.
In the end, the only real market for these metals is the physical market, since futures prices can be manipulated by those who can create money or borrow it very cheaply. Indeed, the precious metals are one of the last remaining markets with a pricing mechanism dominated by paper derivatives, when the commodities themselves are based on a physical unit end point.
Most long term silver investors already understand this situation, in addition to the fact that multiple claims exist for each and every above and below ground ounce of these metals.
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