Recall what happened to gold prices 7 years ago this
month in the Lehman's crash? Wanna bet on a repeat...?
MAYBE it's the end of the world...maybe
there's nothing to worry about, says Adrian Ash at BullionVault.
If the former...rather than blue skies, plain
sailing...how might precious metals respond?
Between the collapse of Bear Stearns in March 2008 and the
crash of Lehman Brothers six months later, the price of gold dropped 25%.
The real start of the real crisis, in other words, was
ignored by the mass of investors, professional and private. They assumed
things were just fine..."contained" in the words of the time...and
resolved by the US Fed arranging a rescue of the credit bubble's worst
miscreant.
Indeed, speculators in the US gold futures and options
market halved their bullish betting on gold...and doubled their bearish bets
as a group.
Because, what could go wrong?
The worst behaved bank wasn't the biggest, however...nor
the worst. And when the cracks in the wall really broke and the whole dam
collapsed, the dash for gold began amid the worst slump in global trade and
credit since the 1930s.
At first, gold prices shot higher. Then they crashed with
everything else...swinging $100 per day at one stage to hit 13-month lows
fully one-third beneath the Bear Stearns' high of March 2008.
How come? Even as physical demand from 'real money'
investment managers and private investors leapt, it also destroyed much of
the financial credit needed by hedge funds and other speculators who were
betting that gold would rise via the US Comex derivatives market. Silver got hit
even worse, as we explained as the dust began to settle.
Tail wagging dog? The relationship between derivatives
betting and the gold price is, perhaps, controversial. Whether derivatives
trading can determine the physical price long term is far from clear. But
looking at US regulator the CFTC's weekly commitment of traders data, the plain fact
is that positioning by speculative players (ie, those futures and options
traders working outside the miners, refiners or bullion banks) shows a very
strong, positive correlation with prices on a short-term basis.
Week-to-week, the average correlation of Dollar gold
prices with the 'net spec long' position (ie, the number of bullish bets
minus bearish bets held by that group) has been 0.87 over the last 20 years.
It would read 1.00 if they moved absolutely in lock-step with each other.
Anything over 0.70 would be deemed 'very strongly positive' by statisticians.
You can see the recent relationship here.
Could a Lehman-style crash (if it strikes) force gold
lower again in 2015, thanks to a loss of speculative credit across financial
markets sucking some 'air' out of prices short-term?
Maybe. The big difference from today against summer 2008
is that speculative traders are now very much less bullish overall, both
because that group holds fewer bullish contracts in total (barely 25% as
many) but also holds many more bearish bets (almost 4 times as many) as on
the eve of the last crash.
The 'hot air' of derivatives credit, in short, has now
inflated the bearish pressure on gold prices. Should it suddenly gush out, we
might expect prices to rise, or at least to escape the deflation they
suffered when credit was pulled from the much more bullish market of 7 years
ago.
No guarantees, of course. Because if you dare recall the
panic sweeping the markets...as well as businesses and households
worldwide...7 years ago, you'll remember what a real financial crisis looks
and feels like.
Buying credit-crunch insurance wasn't so plainly smart
when the end of the world seemed at hand. Hence the volatility.
For now, and given that futures and options contracts do
reflect the broader sentiment of professional money managers, note that the
ratio of bullish to bearish bets amongst speculative traders now stands at
levels last seen in 2002...down below 1.5 bullish bets for every bearish
contract.
Compare that with the 20-year average of 4.1...or the
2008-2009 peaks near 15-to-1.
Sure, sentiment surveys say that money managers are far more
cautious today about the outlook for world stock markets and 'risk' assets.
But what they say and what they do are two very different things. And actual
behavior, meaning the trades they've put on using client money, suggests the
complacency which whacked the investment industry in 2008 is very much
greater today.
Maybe the City, Wall Street, Frankfurt and the rest have
been calling it right, selling and shorting gold while piling on equities and
corporate bonds. They certainly seemed to think that was the right call,
judging by behavior. Right up until the economic data has now started to sour.
