Morning Gold Fix – July 9, 2010

FMX | Connect – www.fmxconnect.com - (Reported 7/9/2010)

The following is a summary of yesterday’s US gold activity and a recap of Asia & European markets overnight. It includes our proprietary options analytics and news stories from industry professionals.

Summary

Gold opened Thursday’s trading slightly above 1200, where it hovered for most of the day before finishing just below at $1196.1 per 100 troy ounces. Barring a significant rally, Gold will finish down for the third straight week.

Bullion Dealers and  the Comex/ OTC Arb:  Part Two

When a Bullion Dealer takes the other side of a client trade, he must decide where to best lay off the price risk. In our example, a miner calls the Dealer and sells to him. The Dealer has several choices on where to hedge. His decision analysis includes weighing many factors like: Will the client unwind this at some point, what does my current book look like, is there anyone in house that I can lay this off with (client or trader), when do I get my bonus etc.

But the most important short term factors involve getting out of the risk

1. Where can he lay it off quickly and liquidly

2. What venue offers the best correlation

Cutting to the chase, the answer is almost always front month futures on Comex. It offers good continuous liquidity, and has very short term risk converging with cash in less than a month.  In our example, the Dealer would sell Comex front month. His risk would be futures vs forward risk: he is long a forward and short a future. Not much risk here, as forwards/ futures are tied by carry cost. His other risk is term risk. He is short a 1 month contract and long a 1 year contract. On paper this is a mathematical cost of carry risk with storage costs thrown in. And because Gold is not consumed in any meaningful way, ( all the gold ever mined still exists somewhere) there should be no risk of short squeeze imbalances like in industrial commodities. Essentially Gold term structure follows bond yields as they should be based on opportunity cost only. 

So, back to our Bullion Dealer. He has 2 clients let’s say. A traditional hedge fund who specs on the buy side, and a miner who hedges on the sell side.  The hedgie will initiate via purchases and will always roll or sell when he has had enough. So the Dealer will be flat form that client on his Comex/OTC risk at some point when the fund unwinds. But the miner, keeps selling to him. He does not unwind. He either lets it go to delivery or rolls his hedge back on the curve as time moves forward. In our imperfect example, the miner does a little of both every year.

What does the bullion dealer have to do then?

He must roll his own short on Comex back deferring delivery because he does not want to make it. If he keeps rolling it back it will eventually roll as far back as the original hedge the miner put on. Convergence and liquidation. If only it were that easy. What ends up happening sometimes is that the position grows as it is rolled back, like a snowball. Rolling liquidity  becomes an issue at some point and he must look for other means of exits like leasing metal, or using other instruments to flatten out risk. This is where the EFP comes in.

The Exchange For Physical represents the difference between spot Gold and the front month future on Comex. This is the Arb that people talk about.  We’ll cover the EFP, its use as a short squeeze barometer and how someone with a monster snowball position in it and no exit strategy can get screwed if someone were to take delivery. It’s a lot like a Martingale bet in roulette, with  zero being the short squeeze. The Dealers keep putting more on (moron!) waiting for Black to come up. Problem is , the traditional hedge funds aren’t playing with them much anymore, so their client books are inherently imbalanced, or “asymmetric” like the smart guys like to say. Easy pickings for someone who wants to turn the tables on them. Don’t believe me, just ask Warren Buffet.

-Elizabeth Thawne

For Market Prices Click Here

Daily Options Recap

It was a sleepy day for options activity on the floor. The day started out with buyers bottom fishing on October volatility. It ended with back month longs running for the hills. On the floor, there was call spread buying in October, and calls selling in June. Dealers traded both sides of the June 11 fence. Retail buy orders seem to have dried up which is consistent with the futures behavior. August continued to weaken with put offers leading the charge. These last three days have seen an unwind in the deferred month month buying, which was a hallmark in the rally. OTC saw locals trying to square up their risk in December 11 via wide call butterflies.

Thursday Options Report

End of Day Straddle Runs

FMX Morning Newswire

Bloomberg (Reported 7/9/2010)

“Gold, heading for a third weekly decline, may reach a short-term low in the next week and climb higher, according to technical analysis by independent analyst Jim Stellakis. The attached chart shows prices formed a low about every 35 days in the past 10 months, with each new trough being higher than the last except for at the beginning of February.

A failure to repeat the pattern may push prices down toward gold’s long- term trend lines between $1,130 an ounce and $1,180, depending on the speed of the decline, Stellakis said. ‘This suggests that gold should find a bottom over the next week,’ said Stellakis, founder of New York-based research company Technical Alpha.” Gold May `Bottom' in Next Week on Low Cycle, Then Rise: Technical Analysis

NS Futures (Reported 7/9/2010)

“In general, the gold trade continues to fear a further tamping down of flight to quality sentiment, as the flow of patently discouraging news from the Euro zone this week has been accentuated by some positive US economic news flow from the US. With US ongoing claims technically forging a downside breakout on the charts yesterday, some traders jumped to the conclusion that the US economy was holding together better than recent expectations.

While equity markets in Asia and Europe are generally higher this morning, US equity indices are reflecting small losses during the initial Thursday morning trading action. The Dollar is moderately higher against most of the major currencies going into the US opening today, with minor losses to the Pound and Canadian.” Daily Metals Commentary 

Reuters (Reported 7/9/2010)

“Gold held just below $1,200 an ounce on Friday as some buyers were tempted back to the market by the metal's fall to six-week lows, but recovering risk appetite is undermining its haven appeal. Spot gold was bid at $1,197.15 an ounce at 1109 GMT, against $1,196.48 late in New York on Thursday.

U.S. gold futures for August delivery firmed $1.10 to $1,197.20. The metal has recovered after falling to its lowest since late May on Wednesday at just above $1,185 an ounce, but has since struggled to make new headway.” Gold holds near $1,200/oz; risk appetite caps gains

For More

Energy News

Precious Metals

Softs & Ags