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“When Price No Longer Matters” – How QE Destroyed Price Discovery And The Free Float Of Government Debt

"When Price No Longer Matters" – How QE Destroyed Price Discovery And The Free Float Of Government Debt

There is a simple reason why we have…

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This article was originally published by Zero Hedge

“When Price No Longer Matters” – How QE Destroyed Price Discovery And The Free Float Of Government Debt

There is a simple reason why we have been getting increasingly more frequent headlines such as these in recent years: Not a Single Japanese 10-Year Bond Traded Tuesday, How BOJ Crushed Trading in Japan’s $10 Trillion Bond Market, Trading in Japanese government bonds is drying up. Does that matter? That reason is that as price indiscriminate central banks soak up increasingly more in Treasury supply from the private sector, the entire price discovery process becomes corrupted to the point where arms-length transactions are no longer required, or even take place, as markets anticipate central banks to set prices without outside intermediation.

And while we have been discussing the growing illiquidity and the decline in Treasury market trading for nearly a decade, others are catching up, and in a recent chart, Deutsche Bank flagged that the share of government debt held by “price sensitive” investors – what the ECB dubbed dubbed the Free Float – has been falling in recent years across major economies and particularly in Germany, where it is now below 10%!

And since QE is set to come back with a furious vengeance once the current period of transitory tightening (see, there is one thing that is truly transitory these days, and that is the period of time that central banks think they can tighten/hike rates/not engage in gross debt monetization, everything else is a joke). ends, below we take a more detailed look at the drivers and potential impact of these dynamics.

For those pressed for time we will generously cut to the punchline: while large FX reserve holdings of Treasuries and Bunds by foreign central banks drive the Free Float in the US and Germany, QE is unsurprisingly the key factor in the declining free float in the other analyzed countries. Yes, for all the Fed’s posturing about the broken Treasury market (see “Two Fed Presidents Hit The Alarm Over The Broken Treasury Market… Which They Caused“) it is the Fed, and only the Fed, that is responsible for the upcoming historic bond market crash.

So what drives Free Float across countries?

The ECB defines the Free Float as the share of outstanding government debt held by price sensitive investors, i.e., excluding holdings by the domestic central bank (QE), foreign central banks (FX reserves) and pension funds & insurance companies (ALM demand). The charts below show how the holdings of these three sectors (in percent of outstanding government debt) have evolved across the 6 largest DM economies.

Combining the data of the 6 analyzed countries into a ‘global’ series, the chart below courtesy of Deutsche Bank shows a steadily declining Free Float share over the past 15 years.

As the chart on the left shows, the aggregate free float in the six top countries has fallen from around 50-55% in the years before and just after the GFC to around 40% today.

Said otherwise, price-indiscriminate entities account for more than half the free float of global outstanding debt; this means that the price of the most important security across the world – the one that is still viewed by some as the “risk free” asset – is no longer determined by the free market but by a handful of fat, balding academics who have never stepped a foot inside the real world.

This is the most important factor explaining not only the rising fragility of the bond market – so theatrically lamented by Fed presidents, i.e., the biggest perpetrators – but also the enduring decline of the term premium. Figure 10 and Figure 11 show how DB’s preferred measure of the 5s10s term premium in both the US and the euro area decreased alongside the Free Float.

Another observation from the data above: the ever growing influence of QE has been offset by a reduction of foreign official holdings for the US (a great way to disintermediate Chinese Treasury purchases from the fate of US deficit funding). Also of note, even though Japan has a debt/GDP of nearly 240% the free float is less than 30% with QE being the biggest part there.

Why does this matter? Because as one can see in the 6 standalone charts breaking down the free float by country, which shows how the price insensitive holdings have evolved over the last couple of decades, one can better understand financial repression and why real yields are so negative, a topic we covered extensively on Friday in Real Rates At Levels Associated With “Panics, Wars, & Depression”… And What Comes Next Could Be Devastating

Tyler Durden
Sun, 11/21/2021 – 13:10




Author: Tyler Durden

Economics

Will The Fed Break The Economy (Again)?

Will The Fed Break The Economy (Again)?

Authored by Steven Van Metre via The Epoch Times,

Last week, the Fed was handed an unexpected gift…

Will The Fed Break The Economy (Again)?

Authored by Steven Van Metre via The Epoch Times,

Last week, the Fed was handed an unexpected gift as first-time jobless claims fell to the lowest level since 1969, which gives the Federal Reserve the green light to continue tapering its $120 billion monthly purchases of U.S. Treasury and mortgage-backed securities. Given the Fed’s dual mandate of maximum employment and stable prices, low unemployment claims along with a low unemployment rate allow the Fed to focus on combating inflation.

To fight inflation, the Fed only has two policy tools. The Fed can raise the federal funds rate, which is currently at 0 percent, and it can taper or reduce the size of its balance sheet. While those two tools are good at fighting monetary inflation, or rising prices associated with money printing, neither are useful for fighting supply-chain inflation.

The Fed isn’t concerned about how inflation manifests itself but only its ability to fight inflation. At the Federal Open Market Committee’s Nov. 3 press conference, Fed Chair Jerome Powell announced the committee has decided it was appropriate to reduce its asset purchases.

Starting in mid-November, the Fed would reduce its purchases of U.S. Treasury and mortgage-backed securities from $120 billion per month to $105 billion per month. In mid-December, the Fed will further reduce its asset purchases to $90 billion per month. Many pundits believe the Fed will increase the pace of its reductions at its Dec. 15 press conference, which will mark the last Federal Open Market Committee meeting for 2021.

For the Fed, the need to slow the rate of inflation is a matter of maintaining credibility. Congress has assigned the role of maintaining stable prices to the Fed, which has determined that 2 percent annualized inflation is a reasonable target. With the Consumer Price Index rising at a rate of 6.2 percent on a seasonally adjusted rate in October, there are serious political ramifications for Congress should the Fed be unable to control inflation.

Politicians are nervous about the upcoming November 2022 midterm elections as voters tend to have a negative reaction to inflation—particularly when wages are running below the rate of inflation, which they currently are. As of October, total private average hourly earnings of all employees rose at an annualized rate of 4.9 percent, falling well short of the annualized increase in consumer prices.

The problem for politicians is that voters tend to place the blame on those in power by voting them out of office. With President Joe Biden’s renomination of Powell to chair the Fed for another term, he’s placing his party’s future on Powell’s ability to control inflation. While Powell will slow the rate of inflation, the outcome isn’t one either political party wants.

Quantitative easing has been largely responsible for the growth rate of the money supply by forcing commercial banks to purchase U.S. Treasury and mortgage-backed securities with customer deposits. While there’s little evidence to support that an increase in money supply has a direct correlation to an increase in consumer prices, reducing the growth rate of the money supply will slow the rate of consumer price inflation.

Historically, the M2 Money Supply, which includes cash, checking deposits, and easily convertible short-term money, grows at an annualized rate of approximately 6 percent per year. At its height during the pandemic, the M2 money supply rose more than 27 percent annualized and as of October has slowed to 13 percent annualized.

As the Fed reduces its asset purchases, which require an increase in commercial bank deposits, the growth rate of the money supply will fall below its trend rate of 6 percent per year. With less money being created by the financial system, consumers will be unable to afford higher prices. By rejecting higher prices through lower consumption, consumer prices will fall.

In the short term, due to continued supply-chain disruptions, consumer prices are likely to stay elevated. Food, energy, and rents remain high, which will have a direct impact on cash-strapped consumer budgets. Consumers will be forced to reduce their discretionary spending as a larger percentage of their budgets gets allocated to food, energy, and rents.

This is a similar story to that which led up to the Great Financial Crisis, where consumer price inflation outpaced wage growth and the growth rate of the money supply slowed. Consumers then were unable to afford higher prices, which in turn led to a reduction in consumption along with the inability to keep the red-hot real estate market rising. What followed was a financial crisis that nearly destroyed the global financial markets.

While the Fed will be focused on fighting inflation by reducing its asset purchases in the months to come, Powell and his committee seem unaware of how they’re keeping the economy afloat. As the Fed reduces its asset purchases, the growth rate of the money supply will fall below trend, and the economy will likely find itself mired in another financial crisis.

[ZH: Do not forget that the market is already expecting a major policy mistake (or flip-flop), pricing-in a rate-cut between 2023 and 2025…]

Just like the Great Financial Crisis triggered a deflationary crash, the next financial crisis will do the same. While many politicians and the Fed are worried about inflation, as long as the Fed continues to reduce its asset purchases, inflation will be the least of its concerns.

In the meantime, the Fed has the green light to proceed, and you can expect it to until something breaks.

Tyler Durden
Sun, 12/05/2021 – 13:29










Author: Tyler Durden

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Economics

With Inflation Emerging As Biden’s Biggest Nightmare, One Strategist Counters: “Inflation, Like Greed, Is Good”

With Inflation Emerging As Biden’s Biggest Nightmare, One Strategist Counters: "Inflation, Like Greed, Is Good"

Now that inflation is up from…

With Inflation Emerging As Biden’s Biggest Nightmare, One Strategist Counters: “Inflation, Like Greed, Is Good”

Now that inflation is up from 1.4% to 6.2%, and even Powell admits it is no longer “transitory“, BofA’s CIO Michael Hartnett pointed out in his latest Flow Show note what was obvious to most, namely that inflation is rapidly emerging as an economic and political problem, as he points to a chart showing Biden’s approval rating sliding from 56% to 42% YTD as inflation has soared, or as the BofA strategist summarizes, in the context of “inflation, politics (midterms Nov22), and credibility, the Fed set to be very hawkish next 6 months” something the market is finally freaking out over with high-duration (read growth and tech) names tumbling.

Yet while Biden will do everything in his power to crush consumer inflation ahead of the midterms, perhaps even nuking the market in the process (only to force the fed to launch the biggest and probably last monetary stimulus shortly after), some like Academy Securities strategist Peter Tchir take the other side and in a note published overnight in which he channels his inner Gordon Gekko wrties that “Inflation, Like Greed, is Good.

Paraphrasing the best Wall Street movie made, Tchir writes that “Greed, in all of its forms…has marked the upward surge of mankind” and adds that “while I may not believe everything that I write today, it seems as though inflation, much like greed, is in dire need of someone to champion it.

This topic is relevant because, as we first showed on Friday and as Tchir writes today “some of Friday’s price action could be linked to markets pricing in monetary policy mistakes. The shape of the yield curve and the sectors that underperformed all fit into a narrative that could encompass a monetary policy mistake (and is also partly due to the market trying to adapt to The Training Wheels are Off).”

The Academy strategist next makes the point that “the politicization of inflation is the biggest reason that we might get a monetary policy mistake!” and goes on to note that “it is the politicization of inflation (which could lead to monetary policy mistakes), that leads me to take up the mantle and defend inflation.”

As Tchir lays out in further detail in his full note below, here are the core tenets behind his argument:

Inflation is Good

We start by examining what central banks have been trying to achieve, what they’ve achieved, and why they aren’t taking victory laps.

Stagflation is Bad

We agree that stagflation is bad and through a series of charts focusing on jobs and wages, we demonstrate that we are nowhere close to stagflation and the economy is outpacing inflation.

What About Gas?

Somehow inflation always seems to come back to gasoline, and we address some of the absurdity around this issue. We also introduce the concept of carbon offsets and where this fits into the inflation argument.

Hedonic Adjustments

If you didn’t think that we could make an argument that rising gas prices aren’t actually rising, you are in for a pleasant surprise. In all seriousness, thinking about hedonic adjustments for products and processors that are sustainable isn’t as strange as it might sound.

What is Driving Inflation?

It is difficult to argue whether inflation is good or bad if we don’t examine what is driving it:

  • Jobs and wage growth.
  • Supply Chain issues.
  • ESG.
    • Transition plans.
    • Supply chain repatriation.
  • Monetary policy.

Tchir summarizes his controversial argument as follows, “Maybe Inflation Isn’t “Good” But It is Necessary: At this moment in time, I do not see any way of achieving our goals without generating inflation. So long as inflation is accompanied by job and wage growth, who really cares about it?”

Bottom Line: Don’t bet on a policy mistake. Bet on cyclical, domestic growth. As Bud Fox says, “Life all comes down to a few moments” and I think that we need the courage to ride this paradigm shift through and accept inflation as just a part of that goal!

* * *

Tchir’s full note is below:

Inflation, Like Greed, Is Good!

Today, I will channel my inner Gordon Gekko, who told us that “Greed is Good.” That “Greed, in all of its forms…has marked the upward surge of mankind.” While I may not believe everything that I write today, it seems as though inflation, much like greed, is in dire need of someone to champion it.

For purposes of this report, there are a few things to clarify:

  • If I had been Chair of the Fed (please stop laughing), I would have finished with bond purchases a long time ago. I don’t necessarily agree with the path that the Fed took, or some of their inflation goals, but we will play this hand with the cards we’ve been dealt.
  • I’m reasonably on board with carbon and climate efforts, though want to highlight a few caveats, which might get lost in this report as today’s goal is to justify inflation rather than fixate on the details of carbon and climate initiatives:
    • We need a transition plan. I’ve harped on this and we see the harsh reality in Europe almost every day. Without a well thought out transition plan we put ourselves at risk.
    • Incentives and rules are ripe for manipulation. Any policy or rule instantly creates a cottage industry for those trying to get around it (and for those trying to take advantage of it). It may well be that the goals are laudable enough that we can tolerate or even benefit from this behavior, but ignoring this reality doesn’t help us much.
    • Acting without China’s full cooperation is a very serious issue. The climate is global, so without China, a massive contributor to the world’s carbon issues (including plastics, and other nasty environmental issues), we run the risk of not only failing to fix the problem, but getting left behind economically and in terms of global power (not power, like energy, but power like might).

This topic is relevant because some of Friday’s price action could be linked to markets pricing in monetary policy mistakes. The shape of the yield curve and the sectors that underperformed all fit into a narrative that could encompass a monetary policy mistake.

The politicization of inflation is the biggest reason that we might get a monetary policy mistake! It is the politicization of inflation (which could lead to monetary policy mistakes) that leads me to take up the mantle and defend inflation.

Inflation is Good

Whenever I focus on a topic, I try and figure out what the smart people are thinking. What do the people who live and breathe inflation think about it? Well, until about a month ago, every single major central bank was fixated on generating inflation. Generating sustained inflation (at an acceptable level) has been one of the main goals of monetary policy across the globe for years (if not decades).

So, we have a group of very intelligent people from across the globe who’ve fought to create inflation for years (which I take as one sign that it might be a reasonable goal). Does their sudden aversion to inflation represent a real shift in their thinking? Or are they bowing to political pressure?

It seems somewhat odd that this group has finally started to achieve their goal and rather than doing victory laps, they are barely defending their actions. It is this behavior that sparks my fear that we could get a policy mistake – not because they think their policies are wrong, but because they face intense political pressure to adjust their policies.

We will come back to why inflation is good in a moment, but let’s address why it isn’t bad.

Stagflation is Bad

We can all agree that stagflation is bad. That slow growth coupled with high inflation is bad. Thankfully that is NOT what we have right now! We have inflation (I’d argue more medium than high), but we have STRONG growth!

While not quite back to pre-pandemic levels, the number of people employed in the U.S. is at a level that has only been better for a few months in the entire history of the country.

I went with the non-seasonally adjusted version since I think that the seasonal adjustment this year will turn out to be incorrect. At the same time, we have a record number of job openings and people are extremely comfortable quitting their jobs!

From a job’s perspective, the economy looks pretty darn good! This is the jobs picture without any form of infrastructure spending getting passed (which should only increase the outlook for jobs). It will also increase inflation, but isn’t that worth it?

Not only are there jobs, but the pay is pretty darn good!

Average hourly earnings are now much higher than they were pre-pandemic and are at their highest levels ever. The average hourly pay just before the pandemic was $23.88 and is now $26.40, almost $3 per hour higher, and that will buy a lot of gas (more on that later).

Even adjusted for inflation, they are 2.2% higher than they were before the pandemic started. This doesn’t even attempt to account for all the benefits that have been paid to people over the past few years, including the signing bonuses many are getting. If anything, the official wage data understates the total income people are receiving.

So, jobs are coming back with a vengeance and they are paying more. Heck, the pay is keeping workers ahead of inflation, and while I do not think inflation is transitory, I do think it will settle into a range between 2% and 4%, which should be low enough (if we can maintain growth) that almost everyone who is working will be better off!

What About Gas?

Somehow inflation always seems to come back to gasoline. I’m not sure about you, but I probably use less than 10 gallons of gasoline a week. I checked and according to the U.S. Department of Transportation’s Federal Highway Administration, the average American drives 13,500 miles per year (higher than me but seems reasonable). They choose to use Ford F-150’s average miles per gallon (which seems conservative) to come up with 562 gallons a year (weirdly, not much above my guess of 10, which means that on average, Americans buy less than 2 gallons of gas a day!)

So, for all the handwringing about gasoline prices (something sensationalized by the media, which has sparked interest from politicians), most people can pay for their extra cost of gas with 1 hour of their higher pay. Seems like a reasonable trade-off.

While this data series only goes back to 2006, average gasoline prices were higher for several years as we emerged from the GFC. They are up about 51 cents per gallon since late 2018 (so $1 a day for the average American).

There are huge differences by state. According to AAA, California is at the higher end at $4.68/gallon, while New York is $3.54 and Virginia is $3.22. Not all states had similar moves in gasoline prices and we shouldn’t ignore various state rules that cause their gas prices to be different.

While I’m not here to argue about European gas prices, I cannot help but bring up the following chart, as I think it is crucial to the inflation is “good” argument.

This is the EUA carbon allowances front contract. My understanding is that refiners, amongst others, are forced to buy offsets to their carbon footprint. The rise in prices would make even the crypto market green with envy!

Hedonic Adjustments

For some reason, I want to call them “hedonistic adjustments” when the BLS adjusts prices to account for quality.

It is something that they have done for a long time. It is questioned by many, but it is a tool that they use to try and reflect large changes in quality that can affect prices over time.

So, if you have gasoline that protects the environment (because the refiner had to offset their carbon usage), did the price go up? That sounds weird at first, but that is the nature of hedonic adjustments.

Is gasoline that will “save the planet” better than gasoline that doesn’t offer that? For this portion, I’m going all in on the carbon/climate side of things.

The price will go up because the offsets are a cost and some of that will get passed on to the consumer, but if you are willing to believe that 2,000,000 pixels are so much better than 2,000 pixels and the price of that “thing” hasn’t really gone up, then why not accept that products that are made more sustainably or have purchased carbon offsets are better? Please go back to my caveats from earlier, I haven’t forgotten them, I’m just getting on a roll here.

This all gets tricky (I don’t have any answers) and this gets a little bit away from the “inflation is good argument”, but this is tied to it because it would be a reason to accept higher prices.

What is Driving Inflation?

Whether we are going to hedonically adjust for prices or not, let’s look at what is driving inflation:

  • Jobs, wage growth, and government payments (though these are less important now than during the worst parts of the pandemic). Plain and simple, jobs and wages are boosting inflation and I don’t see that as a problem. Should we not try and rebuild our often-decrepit infrastructure and not create jobs and demand for raw materials that would increase inflation? That seems silly to me.
  • Supply Chain issues. Trying to address some of these. Whether it is overtime at the ports or flying goods in, etc., both have a real cost. Much of this will dissipate over time as countries across the globe figure out what the new post pandemic normal is. This should somewhat take care of itself and is somewhat out of our control.
  • ESG. I’m not going to spend much time on this as I’ve written so much about the subject over the past year, but I want to highlight a few things:
    • Any transition plan will call for massive investment in new things, but there will be maintenance investment required for old things for some time (i.e., more money will be spent than if we weren’t transitioning). That will be inflationary, but I don’t see how to avoid it (or why we’d want to avoid it).
    • Supply chain repatriation. Some of the existing supply chain “issues” will be resolved by shifting where things are made (including domestically). Some industries, like anything related to healthcare, will feel intense pressure to produce in areas where we have complete faith in the jurisdiction and quality of the products as well as access when we need them most. This will have a cost, but will create jobs, so again, I’m not sure why we wouldn’t accept inflation as a cost of this.
    • Monetary policy. I didn’t even bold this, because quite frankly, when I think about what is causing inflation, monetary policy isn’t high on my list. Which is why I’m so concerned that we could see a monetary policy mistake as the politicians weigh in.

Maybe Inflation Isn’t “Good” But It is Necessary

At this moment in time, I do not see any way of achieving our goals without generating inflation.

If national health and safety is a goal, then how do we achieve that without inflation?

If carbon reduction and sustainability is a goal, I don’t see how we achieve that without inflation?

So long as inflation is accompanied by job and wage growth, who really cares about it?

Again, I’m not sure I want to go down these paths, but if people are correct and this is saving the planet, maybe it’s not inflationary at all compared to the cost of not doing it. Okay, that statement is a bit out of my comfort zone, but there are many who adamantly argue this point.

I think that the stupidest thing we could do right now is cut off our growth trajectory because a few politicians can’t do basic math, can’t understand that there will be some trade-offs, and are pandering to some audience who isn’t more than benefiting from the economic growth being generated as we make massive changes to our economy and how we compete globally.

So, what the heck, inflation is good while accompanied by growth and it would be a policy mistake to kill that growth too early (especially when monetary policy isn’t what is driving inflation in the first place).

Bottom Line

Don’t bet on a policy mistake. Bet on cyclical, domestic growth. Credit spreads should do fine from here. Yields should drive higher and steeper and while I think that some recent market excesses and extreme positioning will continue to work themselves out (bitcoin is below $50k as I type this), the end to the recent volatility is coming closer.

As Bud Fox says, “Life all comes down to a few moments” and I think that we need the courage to ride this paradigm shift through and accept inflation as just a part of that goal! Be vigilant for signs of stagflation, but don’t kowtow to ill-informed soundbites.

Tyler Durden
Sun, 12/05/2021 – 12:00








Author: Tyler Durden

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Precious Metals

Hedge Funds Are Driving Price Action In The Gold Market

Hedge Funds Are Driving Price Action In The Gold Market

Via SchiffGold.com,

Looking at the data, it appears hedge funds are currently driving…

Hedge Funds Are Driving Price Action In The Gold Market

Via SchiffGold.com,

Looking at the data, it appears hedge funds are currently driving price action in the gold market

Please note: the COTs report was published 12/3/2021 for the period ending 11/30/2021. “Managed Money” and “Hedge Funds” are used interchangeably.

The Commitment of Traders analysis last month showed that selling had been exhausted and hedge funds were going long again. It highlighted the trouble gold faced at the $1,800 level. After the October Jobs and Inflation data, hedge funds went big into the market driving prices solidly through $1,800 before the market ran out of steam at $1,870.

The multiple attempts on $1,870 in rapid succession looked like another resistance would fall and send gold up through $1,900, especially if Brainard was nominated as Fed chair. Unfortunately, resistance held strong and a Powell nomination sent gold back through newly established support, which proved much more fragile on the way down vs the way up.

Gold is trapped below $1,800 again. A very weak jobs report provided only enough fuel to keep gold flat on the week. Will a hot inflation report next week be perceived as a “hawkish fed trade” or a “wealth preservation trade?” It all depends on managed money. The hedge funds are in complete control of this market at the moment as the data below shows.

Gold

Current Trends

Managed Money/Hedge Funds Net Longs increased slightly since last month, from 86k to 92k in November. On Nov 16, net longs peaked at 142k. This positioning accounts for the round trip gold took during November.

As the chart below shows, the November peak in longs did not see the same price appreciation as earlier this year. For example, in June of 2021 aggregate Net Longs were reaching 250k and the price of gold was at $1898. November saw net longs peak at 287k vs a price peak of $1853 on the same day (note: the price did reach $1879 but not on the same day as CFTC reporting).

Figure: 1 Net Notional Position

While “Other” has stayed relatively flat over the last several weeks with healthy long positions, Hedge Funds have been in and out. To see the strength of the correlation, the chart below zooms in on only Hedge Funds but extends back to Jan 2018. Hedge Funds have taken back control of the market. Their positioning is driving the price action each week. The peaks and valleys are perfectly aligned.

Figure: 2 Managed Money Net Notional Position

Putting actual numbers shows the true effect. Below lists the year and the Hedge Fund correlation vs “Other” correlation:

  • 2017 .87 vs -.73

  • 2018 .94 vs -.74

  • 2019 .96 vs .57

  • 2020 -.8 vs .64

  • 2021 .82 vs -.02 (YTD)

  • 2021 .85 vs -.43 (July – Nov)

The Hedge Funds lost control of the market in 2020. This is when Other actually drove the market higher. The group was helped by strong ETF flows and record delivery requests at the Comex. 2020 created a new baseline price in the metal. For example, in April 2019 Managed Money Net longs stood at 37k with a gold price of $1,303. On Sept 28, 2021, gold net longs reached 30k vs a price of $1735. At the moment $1750 is showing as strong support just as $1800 proves hard resistance.

Correlation does not prove causation, but the data makes a compelling case for Hedge Funds driving price action. Bottom line: the “weak hands” of Hedge Funds are dominating the short-term price movements of gold, but the physical demand keeps the market trending upwards.

Weak Hands at Work

The chart below shows the week-over-week change by holder. The Hedge Funds spent 4 weeks building long positions followed by two weeks of hard selling. The traders are not in the market because of the fundamental reasons supporting the case for gold. They are jumping in and out, trading the news to make quick money in highly levered positions.

True investors should ignore this short-term movement and recognize the power of physical metal as insurance against government ineptitude.

Figure: 3 Silver 50/200 DMA

Still, for investors frustrated by the price movement, looking at the Hedge Fund trading provides a clear explanation. The table below has detailed positioning information. A few things to highlight:

  • The Managed Money Net Long monthly increase was driven primarily by shorts

    • Shorts have moved lower from 55k to 45k

    • Longs fell over the month from 141k to 137k

  • Other the past week, the move was primarily long liquidation from 152k to 137k

  • “Other”, which still represents the biggest Net Longs, was also driven by shorts closing

    • Longs were flat over the month at 172k

    • Shorts decreased from 44k to 39k, all of which came in the most recent week

It looks like there is “dry powder” on both sides of the equation. The monthly move was driven by shorts closing, but the weekly move was driven by longs closing.

Figure: 4 Gold Summary Table

Historical Perspective

Looking over the full history of the COTs data by month produces the chart below (please note values are in dollar/notional amounts, not contracts). The chart shows the last run-up in price in 2011, followed by the slow fall into 2015 until the new bull market started in 2016. The response to the Trump election (gold sold off hard) can be seen clearly in the sharp drop-off in late 2016.

This chart also shows how big the “Other” category has become on the long side. In 2011, Other Long had $8.6B in gross long vs $30.6B in the most recent period.

Figure: 5 Gross Open Interest

The CFTC also provides Options data. This has mainly been dominated by Producers, but recently Managed Money has played a larger role within the market. The current period shows a similar trend with Managed Money Longs decreasing from $2.8B to $2.4B during November.

Figure: 6 Options Positions

Finally, looking at historical net positioning shows the correlation of Managed Money positioning with price. The peaks and valleys in price are mirrored in the open interest. The correlation did strongly diverge last year after the March 2020 sell-off. Hedge Funds continued reducing net long positions even while the price rose dramatically. This was probably due to strong ETF buying which won’t show up in the futures.

Note: The correlation will look stronger because price is half of the Notional value equation

Figure: 7 Net Notional Position

Silver

Current Trends

The most recent move in silver was actually driven by Non-Reportables rather than Managed Money. While Hedge Funds were responsible for the drubbing silver took in September, their current net longs stayed relatively stable compared to Non-Reportables.

Figure: 8 Net Notional Position

This can be seen more clearly in the weekly chart. While Hedge Funds did liquidate the last two weeks, they only unwound some of their recent positions. Non-Reportables unwound their entire new position and then some.

Figure: 9 Net Change in Positioning

The table below shows a series of snapshots in time. This data does NOT include options or hedging positions. Important data points to note:

  • Within Managed Money, the monthly change was a modest 1600 decrease and was even positive last week

    • Longs drove most of the move, going from 52k to 54k last week and down to 48k this week

  • As of last week, NonRep had increased net longs by 3k contracts, 4x the movement of Hedge Funds

    • Longs went from 13.9k to 16.9k and down to 13.5k

Figure: 10 Silver Summary Table

Historical Perspective

Looking over the full history of the COTs data by month produces the chart below. The chart shows the last run-up in price in 2011, followed by the slow fall into 2015. The price collapse in silver in 2020 is clearly visible in this chart. As can be seen, gross longs are still well above the 2020 lows.

Figure: 11 Gross Open Interest

The CFTC also provides Options data. This has mainly been dominated by Non-Reportables, exceeding even Producers. Options have fallen off significantly from the spike last July and is still well below the peak in 2011.

Figure: 12 Options Positions

Finally, looking at historical Net positioning shows the correlation of positioning with price. Similar to gold, the peaks and valleys in price are mirrored in the open interest. Again, the latest pop did not generate the price increase that would have been expected given the magnitude of the move.

Figure: 13 Net Notional Position

Conclusion: How Will Hedge Funds Respond to the Fed?

Hedge Funds certainly trade using technical analysis, which is why Fib targets and round numbers (e.g. $1,800) prove to be such difficult resistance points. Over time, the physical market has pushed prices up, but the short-term move is dominated by hot money. How long until Hedge Funds call the Fed’s bluff? More importantly, how long until there isn’t any physical to back the paper contracts because it’s been delivered and then removed from the vault?

Astute investors should keep the long-term picture in mind. The short-term gyrations can be immensely frustrating, but gold and silver are not Bitcoin. They are not vehicles to get rich quick because that would disqualify them as safe-havens. Remember, what goes up quickly, can come down quickly. Stay the course, trust the fundamentals, use the CFTC analysis to explain the short-term price movements, and understand the protection provided by physical precious metals.

Tyler Durden
Sun, 12/05/2021 – 11:30






Author: Tyler Durden

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