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Five Things You Need to Know About Gold


What you need to know about Gold (and what it means)!


1. Carry Trade Nonsense

  • The new "wise guy" hedge fund trade of the week last week was apparently that there must be a yen carry trade in anything that was down on Tuesday when the yen popped 2% (note the yen is up another percent today).
  • As I've said, I think it's pretty safe to say that this is complete nonsense when it comes to gold.
  • Carry traders are yield pigs, they don't borrow yen and buy gold. But the rumor was everywhere on Friday that a big carry trade in gold was blowing up. So, that's the rumor that appeared to be what sent already-scared longs over the edge and no doubt also brought in a large number of shorts (markets breathe, and any old excuse for a selloff will do when it's time for one).
  • Although judging by the open interest (which actually rose on Tuesday), we may have had a lot of shorts come in mid-to-late last week based on the idea that there was a yen-carry trade in gold (see the open interest in "red" below, which rose to a new record as of Wed's close and barely even ticked down on Thursday).

  • If that's the case, they're going to be forced to cover this week, meaning that gold's rebound could be fairly violent. We'll get Friday's open interest later today. It should be interesting to say the least.

2. Pump Fake

  • Regarding the yen carry trade nonsense: Note in the chart below the last time that we had a head fake down in gold during a big yen rally:

  • A simple glance at the yen vs. gold over the past year shows zero correlation between rallies in the yen vs. selloffs in gold.
  • Not only that, but gold rallies have actually been positively correlated to rallies in the yen for obvious dollar-related reasons. In fact, the last time we saw a rally in the yen that also coincided with a head fake to the downside in gold was back in December of 2005, which also happened to be the beginning of a huge move up in both gold and its shares.
  • I hadn't expected Friday's swoon in the metal, but if it is a head fake, like I think it is, then the rebound could be rather violent.

3. Gold Shares

  • The shares should see an equally violent rally in my view.
  • Note that a huge 10,500 GDX March 38 puts and another 10,000 Apr. 37 puts were purchased on Friday vs. only a handful of calls (see the table below), I find it be unlikely that we'll see a meaningful penetration of even Friday's lows on a closing basis.

4. Speaking of Cheap Shares

  • I cannot stress enough how cheap the shares are now getting relative to gold, and to see them rally soon (regardless of what the metal is doing on any particular day) would not be too surprising.
  • Note the XAU/Gold ratio below that is sitting near the lows of its trading range since the bull market began back in late 2000.

5. Where does the Fed go from here?

  • Regarding the Fed's potential reaction to the meltdown in the subprime mortgage market, note that NY Fed President Geithner gave a speech on Friday regarding liquidity in financial markets (keep in mind that these guys do nothing by pure coincidence). He said, "As always, central banks need to stand prepared to make appropriate monetary policy adjustments if changes in financial conditions would otherwise threaten the achievement of the goals of price stability and sustainable economic growth." He might as well have added a wink and a "Hint, Hint…" at the end of that.
  • I'm continuing to see evidence of the subprime mortgage rot spreading to midlevel loans between subprime and prime (also known as "Alt-A" mortgages). Remember how everyone said the rot wouldn't spread? Wrong. Get ready for rate cuts, because this is a system wrecker if it continues to work its way through the financial system at its present pace.
  • Will the Fed ease if the turmoil in the markets continues over the next three weeks ahead of the FOMC? You bet it will. I'm not sure such an easing will do anything for stocks other than provide some footing for a bounce, but that's definitely bad news for the dollar and good news for gold.
Position in gold, gold shares

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