Blowing Smoke in the Gold Market

Those who know me also know I am a financial news addict. I'm reading the latest international market news while drinking my first cup of coffee. This often means I'm in a foul mood and known to post caustic aka socially incorrect comments in reply to what I deem to be a nonsensical analysis.
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As an example an analyst stated the following this morning:
"We'd prefer to see Gold below $1100 and Silver below $14 before thinking about buying."

Why not prefer gold at $2.17 and silver at $0.05?
Get real.
Both are already in a multi-year low range.

I'm a bit curious about what pricings you preferred over the last 6-12 months.
I'd almost bet they were higher.
They don't ring any bells at the bottom.

I would offer the most logical approach is modest and continuous buying all the way down. Constantly
lowering the average purchase price.
Logic would demand holding rather than booking a loss. Any profit or loss on paper is nonsense. There are
no profits or losses until the money changes hands.
But we are faced with a "I want a staggering amount of wealth now" crowd. Paper profit/loss brings out
emotion driven reactions.
And whenever there is emotional market participation, there are always plenty of folks eagerly selling
them smoke.

I would offer the following:
If you don't know the market, you have no business participating in it.
That includes through all the various proxies.
Because if you don't know the market, how do you know you aren't paying for smoke?

So why would I offer such a caustic retort?
Consider this.
The gold and silver market is dominated by the futures market.
This is where copious amounts of  money gets won or lost.
The following is a grossly simplified explanation. Emphasis on grossly simplified.

At the current $1150 USD per ounce of gold and every futures contract is for 100 ounces, this means every contract is for $115,000. This contract can be secured for just $3750 USD. That is roughly 31:1 leverage.
It also means a modest 3.3% drop in price wipes out the margin. Ergo the folk scramble to buy long contracts to counter the loss. A short sale gone south mandates buying a long to cancel the the short. The only other way to hold out is meeting a margin call.

As margins are effectively down payments on borrowed gold. Either pay back the gold, increase the margin money on deposit or buy an off-setting long. Futures contracts are for future delivery and settling up the differences in price.

Shorts are borrow gold and sell the contract today in hopes of buying back the gold in the future at a lower price than you sold the contract for. Any money left after the sale is profit. As an example a $5 drop in price would result in a $5 X 100 X 31 profit before fees. That is a $15,500 USD profit. Note: A naked short has no gold backing it.

Longs are borrowing the gold today and selling in the future in hopes the price goes up.

In both cases, the margin is roughly 3.3%. Price drops, the folks who lent to you will want that 3.3% increased to perhaps 5% or more. Price rises, you must put more money in the pot to maintain the 3.3% or maybe more. The 3.3% is the minimum margin in effect down payment.

So what does this mean in response to my retort?
All  pricing is dominated by the futures market where the daily paper exchange might be 5%, 10%, or more of the annual amount of physical gold actually transferred between parties.
So we have the price dropping into the dumpster because of shorts. Recall shorts lower the spot price and longs increase the spot price. As the price drops, there becomes a substantial requirement for the short sellers to purchase longs to cancel out the losses the lower pricing will result in.

Keep in mind, that shorts are purchases. You effectively bought it, you are gonna pay for it. All of it. Losses are not confined to your margin aka down payment. Either put up more money in your margin or buy a long to cancel the short. An example would be you rented my riding lawnmower for a month and then sold it. Before the month is out, you have to buy it back or pay me the price we agreed the lawnmower was worth when you borrowed it. I don't care what the price you have to pay is. YOU WILL REPLACE MY LAWNMOWER.

So the futures market concept requires that a substantial drop in price must result in an increased price. Smart money doesn't sell at a loss. Those who hold the gold make the rules. For those already holding the gold, selling will only occur at a much higher price. Remember, those holding will want a profit as well and the short seller is over a barrel.

Here is the real irony. Most participants have no intention of taking possession of the gold. They lack the money to purchase the 100 ounce ingot otherwise they would. No what they are in hopes of is another big score at 1:31 leverage. It is a zero-sum game. Every sale requires a buyer and seller. And someone is holding physical gold.

Here is where it gets interesting and prompts so many fools into the notion of market manipulation. If you hold enough physical gold, you are bound by putting up margins for selling longs. You don't have to borrow any gold. Advantage goes to those who hold the physical gold. Those who squall about manipulation hate the holders having such an enormous advantage. At a 31:1 advantage, the house will always win in the long term. Every margin call wipes out many participants. Others can pay the heavy toll by buying an offsetting long. And those holding get a nice skim every time.

So is there manipulation? You bet'cha. If you are holding physical, nobody can force you to play in the game. If the market participants are eager to get you into the game, they must give you a real incentive. That incentive is the ability to make the rules. One more time: He who holds the gold, makes the rules.

Recall that the futures market requires borrowing the physical before you can sell it? Who do you suppose they borrow it from? Advantage goes to those who hold physical. The whiners hate this advantage. The call it manipulation.

Every participant in every market attempts to manipulate said market to their advantage. The car buyer tries to get the dealer to drop the price, increase the trade-in value or toss in more dealer options. The home buyer tries to get the price down. Even at the yard sale, the standard is haggling. Your grocer or hardware store will quote you a lower price for buying in bulk. In every case, the seller has an advantage unless they borrowed. If time on the borrowed contract is real short, few options remain.

As an example:
ABC Hardware borrowed to buy 50 units of plywood. They borrowed from the bank or the seller at 30 days same as cash, then 12% on the remaining balance. 22 days have gone by and only 2 units have sold.  Options? Reduce profit margin to sell, pay the 12%, borrow to cover or get cut off from the market and still owe the money.

So why do people play this game? Almost everyone wants to get rich on someone else's money. If they already had the money, they would be rich. Oddly enough, the vast majority are never rich enough. Seeking vast amounts of wealth become an obsessive compulsive disorder. It is an emotional response. Fear of  loss.

I will l;eave you with this. Most so-called financial gurus are no better than wild guessing. They are selling sacks of air to an eager, but utterly ignorant market participant. And why would they do this? Because selling hot air gained at no cost is far more profitable than their own trading.

A rising market makes everyone a financial genius. Those who gambled big and won the most are deemed the gurus. They then find that capitalizing in the hot air market will sustain their lifestyle until another rising market happens.

Take what you will from this. I charged nothing. I have nothing for sale. I don't even offer advise. So why do I offer up my questionable opinion? Self-defense. I am of the opinion that things will get far worse before it gets better. I'm pretty certain I will be feeding the worms long before there is "better". Those who gambled and/or are wastrels pose a real and significant risk to me, mine and those who practiced sound wealth management.  I would suggest don't be one of them and guard your and yours well from them. Zombies today, vampires tomorrow.

Bankruptcy begins slow and finalizes at high velocity. It appears that the world has already shifted from low to drive. The engines appear to be re-lining. I have no idea when the drivers will shift from drive to race.

Try to chose your path wisely. Make your own luck. Believe nobody. Not even me. Hindsight is often 20/20 but my foresight was 20/400. I did invest in personal knowledge and what many would call anachronistic skill sets. I contend that those who can do will have value in the future. I will gladly trade you that value on Thursday for a hamburger today.

I never thought the PTB could hold it together this long. But I think I hear the approaching footsteps of inevitability. I leave you with the paraphrased Laws of Thermodynamics which I contend apply to everything.

Everything is connected to everything.
Everything has to go somewhere.
There ain't no such thing as a free lunch. Tanstafl. Forget the double negative. NO FREE LUNCHES.