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The nature of the gold market makes profitable day trading difficult,
if not impossible. It is all about information, or lack thereof. Apart from
pockets of relative transparency (emphasis on relative) like COMEX or ETFs,
the vast majority of the market is opaque. The “retail” or
“average Joe” trader simply does not have access to the same
amount of information about the status of the market and its flows that a
“wholesale” trader does (and even they can’t see the entire
market).
Without understanding what is really driving short term changes in the
price, it is not possible even for the most astute and disciplined trader to
make consistent profits.
Let's contrast it to stock markets. There are a few key features that
help the day trader. Firstly, you know exactly how many shares have been
issued. Secondly, all trading is done through (usually) one regulated market.
Thirdly, you can see daily trading volumes. Fourth, at any point in time you
can see the depth of the market – how many shares are being offered to
buy or sell at each price level.
This mass of data, combined with analysis of price charts, gives the
trader room to apply skill and a bit of gut instinct to the task of making a
profit.
How does the gold market stack up on these features? Firstly, no one
knows for sure at any point in time how much gold there is out there to be
traded, nor in what form or in what locations. The wholesale market may have
a bit of an idea, but no such information is published to retail traders on a
daily basis, if at all. Even if one did know the size of the gold out there
at that point in time, due to its refinability,
scrap gold can flow back into the market quickly (a factor if you are
planning on holding a position for a few weeks), so the total “shares
on issue” in not fixed and changes in response to the price.
On the third and fourth points, there is no published information on
daily trading volumes or market depth; indeed, no volume data is published at
all. I’m talking here about the whole market. Sure, some gold is traded
on regulated markets but that information is only a small part of the
picture. If you only have part of the story, you don’t have the story
at all in my opinion.
Network Nature of the Market
The key killer for me is the second point – gold is simply not a
publicly, regulated traded thing. And COMEX and ETFs and the like don’t
go anyway towards solving that because they are not closed systems. It is
easy to run a position in those markets that are offset or hedged with an
opposite position in the over-the-counter spot/forward market. Detailing how
that is done is for another article. The gold market operates much like the
internet – it is a network of wholesale dealers, independently trading
with each other, and it is the sum of those individual trades that makes up
the “spot market”.
It was always amusing to me when clients would ring up to buy and we
would quote a price and then, naturally, they would say “Well, where
can I get what the spot price is?” so they could work out if our price
was “fair”. The answer was, “It doesn’t exist. You
could spend a few thousand getting a live Reuters data feed, but even that is
just indicative.”
Being used to the comforts of a stock market, many didn’t like
that answer. In the end, all we could say was that they had to do what we
did, which was ring around to see who was offering the best price at that
time. It made some uncomfortable, but this is the “pointy end” of
investing, it’s real trading, it is about bargaining, haggling, being
in the know.
The funny thing is that this network nature also gives the market
strength. Transparency is nice, but not at the expense of robustness. One of
the strengths of the internet is that if a part of it goes down the data can
be rerouted. Gold is the same. If London was nuked for example, then trading
in gold could still continue. Sure, liquidity would be reduced, but as deals
in the end can be done over the phone, it is just a case of dealing with
other counterparties in other countries. Because it is not locked in to one
“exchange”, gold can be resilient in the face of a failure in
part of the network. And this is how medium and long term investors want gold
to trade if it is to be the asset of last resort. The market needs that
flexibility to if it is to continue trading.
But the network nature of the market and the corresponding lack of
transparency is a problem for the day trader. To understand what the retail
trader is up against, it may help to describe what happens when they call up
to buy some gold from a dealer. There are many small variations to how this
can work; this is but one way, probably the simplest where a dealer just lays
off a trade with someone else immediately instead of holding a position.
Spot Trading
Any trading desk needs an indicator of where the market is, and most
use Reuters. However the price displayed on Reuters under code XAU is just an
indicator. It is updated by the bullion desks of the big banks but is in
effect, just a bulletin board or forum where banks can publish their prices
in the hope other dealers will call them up to do a trade. Sort of like an
advertisement. Unlike a stock market, it is not a commitment to deal at those
prices, but most times you can.
However there are many times, especially when the market is moving
quickly, when the dealers don’t have time to update their quotes on
Reuters, that when you ring them up, they say “Sorry, Reuters is off
the market, my current price is $5 below the screen”.
As a result, when you call a dealer for a price, they themselves
cannot really know exactly where the market is. They see $900 on the Reuters
screen, but this is what they will be charged, so they have to add something
on to it as they have to make a profit (you expect something for nothing, it
costs to run a trading desk, to talk to you, to do the other side of the
trade with the bank, to settle the funds, bank fees etc).
The dealer also has to consider that by the time they get off the
phone with you and then call another wholesale dealer the market may have
moved, so they might need to add a buffer on top of their margin. Sometimes
if your deal is big enough and the market volatile, they’ll get another
trader on their desk to call a bank and get a firm price before they quote to
you (and they’ll want an answer quick because the bank ain’t gonna want to sit
on his quote for too long because he/she has got to trade it as well).
Dealers have a network of other dealers they trade with. Each dealer
has a different bit of the gold market pie, they can see what is driving
their deals (be they a refiner selling a miner’s gold, a bullion dealer
selling coins and so on), but not necessarily what is driving other flows.
They are in constant contact with each other, doing deals, talking and
exchanging information on what they are seeing in the market, watching the
Reuter’s price movements. They use all this information to set their
prices and to ensure they don’t lose money. Over time they build up a
gut instinct, a feel for market movements and where it might go that day.
If you call up the Perth Mint to trade, you are likely to speak to Deniece, the Mint's senior bullion dealer. She has what I
would consider probably the best background training for a bullion dealer -
croupier at Sun City. When the market is moving you can do any number of deals
before you have time to enter them into the system to confirm your position
and profit, so you have to be able to run them in your head, to know where
all your 'gold chips' are on the 'table'.
She has been there since 1994 and every working day she has been
sitting in front of a computer screen watching the Reuter’s gold price
tick up and tick down, talking to wholesale dealers and people like you
wanting to buy or sell gold. That is over 4,000 days of trading. And you
think you can day trade against dealers like her, with zero information about
what’s going on in the market? Give me a break.
Bron Suchecki
Goldchat.blogspot.com
Bron Suchecki has worked in the precious metals
markets since 1994, when he joined the Perth
Mint as an Administration Officer in their Sydney retail outlet. In 1998 he moved to Perth to work in the
then fledgling Depository division. He has held a number of roles since then
in the treasury, risk and governance areas of the Mint.
All posts are Bron's personal opinion and not
endorsed by the Perth
Mint in any way.
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