Don't Freak Out: Gold, the Debt Crisis and Janet Yellen

I just wanted to write some quick notes about the last week and the issues involved with gold reaching its lowest point since July of 2010, Janet Yellen replacing Ben Bernanke and the US government shutdown and the impending debt ceiling and what it means and does not mean.

I will likely come back and update this post to expand in the coming days so you may want to revisit it Sunday or Monday.

The government shutdown and debt ceiling.
This subject is never really explained well by media or is explained poorly. In addition, some politicians are out right misrepresenting what will happen for political purposes to scare citizens into action.

The previous spending bill agreed to by Congress and the President has now expired. When they cannot agree on a new spending bill we get a "government shut down". What that means is that discretionary spending cannot continue but essential services are continued. Since two thirds of government spending are made up of entitlements like Medicare, Medicaid and Social Security, that part is unaffected. The rest, either continues or not depending on whether they are essential services or not. One example is most military spending. So as of today's writing about 80% of the normal level of government is still operating unchanged.

The debt ceiling is something different.


Without Congress (meaning the House and Senate) authorizing a higher debt ceiling, the government cannot spend more money than it takes in. Despite what the President has said, that does not mean a debt default. In fact, most legal scholars mean we are constitutionally required not to default. What that means is that tax revenue (about $250 Billion per month) would first have to go to debt service. That means there may not be enough money left over to fund the entitlements mentioned above. This would force the Treasury to prioritize payments.

It would be ugly but not the end of the world nor would it mean a default on US Debt.

Janet Yellen appoint to the Fed
Yellen is widely viewed as even more dovish than Ben Bernanke and therefor less likely to taper. In fact if the economy continues to weaken in the US we should instead expect not only an absence of tapering but likely it may well be increased from $85 Billion per month to something much higher.

Gold pummeled to new multi year lows.
Demonstrating just how overtly manipulated gold and silver prices have become, the metals have been slammed down at a time they should be hitting record highs if they were trading on fundamentals! The two news events above should be scaring the heck out of people out of the dollar and into gold. After all, we've been told the US could default on its debt (though I showed above that that isn't true) and the new Fed head will likely just print more! Its completely non-rational for gold to be declining. As my previous post showed clearly, until the last few years, gold and the US debt are extremely well correlated. So what happened? KWN reports:

“In a deja vu of yesterday, another large sell order hit the electronic futures (we think approximately 800,000 oz), send gold from $1,285 to under $1,260 in quick order.  We have since stabilized in the mid 60's but it appears that deep pocketed speculators may have decided that shorting gold is the “trade de jour”.  Gold volume is up 1% and gold interest rates up 50 bp as the short positioning increases....

So about 800,000 ounces dumped into the market all at once. Amazing. No rational trader would ever do that! It was so sudden that it briefly broke the CME!

There was a time when, if selling a sizable amount of a security, one tried to get the best execution price and not alert the buyers comprising the bid stack that there is (substantial) volume for sale. Of course, there was and always has been a time when one tried to manipulate prices by slamming the bid until it was fully taken out, usually just before close of trading, an illegal practice known as "banging the close." It appears that when it comes to gold, the former is long gone history, and the latter is perfectly legal. As the two charts below from Nanex demonstrate, overnight just before 3 am Eastern, a block of just 2000 GC gold futures contracts slammed the price of gold, on no news as usual, sending it lower by $10/oz. However, that is not new: such slamdowns happen every day in the gold market, and the CFTC constantly turns a blind eye. What was different about last night's slam however, is that this time whoever was doing the forced, manipulation selling, just happened to also break the market. Indeed: following the hit, the entire gold market was NASDARKed for 20 seconds after a circuit breaker halted trading!

From the CME itself:

Stop Logic detects potential market movements caused by the triggering and trading of Stop orders where the resulting price move would extend beyond an exchange specified threshold.

The triggering of Stop orders can potentially exaggerate price movements in temporarily illiquid markets. When triggered Stop orders attempt to move the market to an executing price beyond a pre-established value, a Stop Logic event occurs. Stop Logic detects these situations and responds by placing the identified market in a Reserved state for a predetermined period of time, usually 5 to 10 seconds, depending on the instrument. During the Reserve period, new orders are accepted and an Indicative Opening Price (IOP) is published, but trades do not occur until the Reserve period expires, thereby providing an opportunity for participants to respond to the demand for liquidity. At the end of the Reserve period, the instrument will re-open and matching will resume.

When a futures contract designated as a lead month contract experiences a STOP Logic event, associated options markets are paused and Mass Quotes canceled.

Stop Logic will not prevent markets from ultimately moving in the direction of the order flow, but allows time for liquidity to enter the market so that new orders can be matched against the triggered stop order(s).

This is what it looked like:

 

And this from Andrew Maguire, als at KWN:

Eric King:  “Andrew, as we see this smash unfolding, what kind of (gold) tonnage are we talking about being taken out of the market here?”

Maguire:  “When you see, in one trade, over 80 tons of paper supply coming in, who do you think is on the buy side?  That (chaotic trading) enables the central banks to come in and literally buy (quietly).  Bear in mind that this paper supply which is coming into the market is leveraged, it’s naked and it’s leveraged....

“Unleveraged buying through the spot market is actually hidden, initially, because of this supply coming in, but it will catch up.

So, just today alone when we saw that 80+ tons coming in, you can bet your life that over 80 tons of physical (gold) was actually taken off the market at that time.  I would asses that we are going to see another 250 tons of Shanghai volumes this month, again eating up all of the (world’s gold) production supply. 

Central banks are definitely in here sub-$1,300.  We knew of a very large sovereign buyers that were sitting at $1,270 for days and days and days.  Suddenly that’s filled today (Friday).  It’s all masked by the fact there is so much fake gold in the market that it’s not noticed. 

This last week we’ve seen hundreds of tons of supply coming into the marketplace -- literally hundreds of tons, Eric.  When I say supply, I find it even hard to say that because it’s just paper.  But what it does is dilute the true fundamentals.  We are going to have (Asian) buyers coming in whether the price is $1,800 or whether it’s $1,200.

The point is, when they (the West) discount it (gold) to this degree, what it does is accelerate that process (of accumulation).  But more importantly, it enables the central banks who are trying to build reserves to move in faster and not be visible (as they accumulate).

To be honest, I think the damage has already been done.  The breach, the divergence between the real market and the paper market has reached an extreme which I cannot believe can be maintained.  We are stretched beyond anything that’s credible here.”

Eric King:  “As you’ve looked at this smash, how much gold has the West given up to the East?”

Maguire:  “It’s in the hundreds of tons.  We’ve dropped down from the mid $1,300s in the last week, all the way down nearly $100.  That’s taken a vast amount of paper supply (selling), and that paper supply is being converted into physical (gold) and removed off the market.”

 Conslusion
 So what does all of this mean? Likely China, but possible other central banks are buying deeply discounted gold by the hundreds of tons. If you have been dollar cost averaging your purchases, this is a great time to buy US subsidized gold at about 33% off the rational price.

In addition, Yellen's appointment means the US stock market is likely to go much higher before this all comes to a horrible end. If you choose to invest at this point you should predetermine a level you would sell in a melt down or hedge your portfolio with put options or inverse market mutual funds or ETF's. Please note though, this is not a recommendation to buy, especially while the debt ceiling debate is going on.