The previous essay ended with the statement that October might become a good month for gold. So far it does not look as if this was one of the better forecasts one could make, but October still has some weeks to run before the end of the month. It could still surprise!
October has traditionally been a bad month for equities – also needing some more time to follow the standard pattern of a steep collapse on Wall Street, but the rally of the past few days was more short covering and over-eager bulls reacting to a spate of futures buying than a fundamentally sound trending market. This week should see a reversal downwards again, probably on poor earnings and forecasts from US corporations. Particularly those in the retail market.
All indications are that gold will not easily break the stranglehold that is keeping it below the currently important 5 level, with 0 and 5 also likely to be levels of definite resistance. Last week the point was made that investment demand for gold – from Japan in particular, but also elsewhere – has been picking up, which is positive. But demand for physical gold has to rise even more before there is sufficient upwards pressure on the price to pop through resistance. A steep decline on Wall Street to finally shatter the hopes and optimism of the perma-bulls is one factor that could send a stampede of old bulls into the safety of gold, either in equities or in bullion.
However, this would also require a softer US bond market – currently still the preferred safe haven for refugees from the equity markets. Last week US bond yields reached new record low levels and then turned softer by Friday. The latter might just be a reaction out of bonds and back into equities, but the sudden weakness in the bond market may well be a warning to investors that this haven is overpriced and may not be as safe as they would like it to be. That would leave gold as the clear front-runner in the safe haven stakes.
Another positive factor for gold that still has some way to develop is the ever increasing precarious position of the major players in the gold carry market. The bullion banks have been battered because of their exposure to Enron, WorldCom, Tyco and other corporate disasters. The prices of their stocks are falling rapidly and the ratings agencies are no longer as kind to suffering corporations as they have been in the past – also a legacy of Enron and its ilk and the public’s reaction to earlier laxity in cutting the ratings of firms that are descending into trouble.
With Citibank, JP Morgan and others losing their preferred ratings, they are now being restricted in the ability to deal with central banks – the latter have a standard minimum rating for their counter-parties and at least some of these banks are now being rated lower than that standard. This means that they may no longer have easy access to gold available for leasing. Yet this will only become a crisis when more of the players sink below the critical rating level.
Finally, lease rates for gold that have almost always been very low, recently fell to near zero for the one month contract. There could be two reasons for this – firstly, nobody was leasing any gold and central banks had to lower the cost to entice someone to lease, or the central banks were being kind to the leasing market in an effort to reduce their cost and risk and thereby allow more gold to flow into the physical market.
Since the lease rate was below what one would reasonably expect in terms of the risk that leasing entails – and therefore too low for prudent practice, particularly by traditionally conservative central banks – it would seem that the second reason is the valid one. That in turn would imply that there was a crisis in the gold market that had to be defused.
Now the lease rates have shot sharply higher again, almost as if an awareness of the risks that exists has percolated through to the central bankers, making it a bit more expensive and risky for players leasing gold and selling it to keep the price down.
Oh yes, there are also massive short positions on gold shares in US markets. Almost as if people sold heavily short in anticipation of a steep fall in the gold price. If this should happen, they stand to make a good deal of money – but if gold should suddenly rally there will be a bear squeeze of magnificent proportions, with prices of gold shares rising far more steeply that what they have done so far.
This all adds up to an increasing potential for explosive movements in the gold market. Yet we still have to wait and see whether it will come to pass during this month.