Quantitative Easing Market Distortions, ETF Selling And Futures Trading
From a pure fundamental supply-and-demand standpoint, gold’s sharp drop in 2013 was widely attributable to record gold-ETF selling by mainstream money managers and stock traders. The World Gold Council's comprehensive 2013 data showed that global gold-ETF outflows from epic share selling was actually a third greater than the total worldwide drop in gold demand.
This selling was instigated by the parameters of quantitative easing 3 (infinity), announced in September 2012 that guaranteed open-ended continuance until U.S. unemployment declined to 6.5 percent and the Consumer Price Index rose to 2 percent. The U.S. equity market was the clear beneficiary of capital flowing out of low- or non-yielding financial instruments including gold, which were guaranteed to remain out of favor as long as QE3 existed.
Without those extreme gold-ETF liquidations, gold’s worst loss in a third of a century would not have occurred. Fueling this were U.S. futures speculators who also dumped gold at record rates. The increasingly poor gold sentiment, as capital rotated out of the metal to chase attractive stock mark returns, eventually triggered serious selling pressure in the leading gold ETF, GLD.
Stock investors were selling GLD shares much faster than gold was being sold, creating the biggest correction in GLD’s physical-gold-bullion holdings since the stock panic of 2008-2009.
This gold selling was completely futures-based initially, as the panic started cascading through the highly leveraged futures markets. The maintenance margin on Comex gold futures was just $5,400 per contract when the panic began. That means futures traders could control 100 ounces of gold worth $156,100 for just 3.5 percent down. That’s a risky 29-to-1 leverage!
By comparison, in the stock markets, the Federal Reserve has limited margin to 2-to-1 since 1974. Yet even with 50 percent down, panics are still possible, as we learned in 2008—picture gold futures traders taking 100 percent losses on a 3.5 percent gold swoon. When gold fell 7 percent, speculators would lose twice the capital they originally risked. This is a reminder that leverage is an unforgiving game to play.
The 2013 gold panic was a forced-selling phenomenon driven by a support break crushing over-leveraged futures players. The Fed’s decision in December to start making measured changes (tapering) to its stimulus program boosted sentiment, and the strengthened commitment to keeping short-term rates near low as long as inflation is not an issue, and has greatly benefited gold in 2014.
Our conclusion is that the economy is on track for growth and trading in ETFs such as GLD and the futures market, and central bank behavior will contribute to the current gold-price recovery for as long as the economy supports this growth environment.
Cougar Global Investments, founded by Dr. James Breech, is a Toronto-based money management firm that uses only ETFs in its top-down global asset allocating strategies. He perfected a downside risk management system since founding Cougar in 1993. Contact Cougar Global at 800-387-3779 or [email protected]. Deborah Frame is a portfolio manager at Cougar Global, responsible for model creation using tactical asset allocation and downside risk optimization. [email protected]