Morning Gold Fix: July 12, 2010
Commentary courtesy of www.fmxconnect.com
Gold gained some ground Friday, opening at 1198.5 and closing at 1209.8, its highest close of the week. The trend seems to be reversing this morning however, as it is down slightly this morning.
The Gold/ Comex Arb : Part 3, The EFP and Pot-Odds
As mentioned in Friday’s comment, Bullion Dealers end up having massive positions in correlated assets in an effort to mitigate risk given them by clients . Their most common resulting cross-market position is Comex Futures versus cash gold.
Suppose a bullion dealer’s business was almost entirely made up of producers. He would be getting long the cash market from his clients, and selling Comex futures to hedge his flat price risk. He would have a vested interest in the spread between futures and physical as a result. This is expressed in the Exchange for Physical. The EFP is a very liquid spread used for many reasons. It provides for dealers to reload their open interest guns on Comex, expresses the fungibility between the markets and makes it easier to have liquid environments.
Without getting into too much in this short space right now, to summarize: if a dealer gets a big enough position in the EFP, he must continually roll it out, usually adding to the position through marketmaking to his clients. The EFP is usually not marked to market as 1 leg of it is OTC. It is therefore subject to the same mark-to-myth risk that a CDS is. these positions can get very big. There size can get to the point where a bullion dealer initiates trades using “Pot-Odds” as his risk measurement, not VaR. One way a bullion dealer could create his own exit strategy from his EFP position is this
Position : Short Comex gold, long OTC swaps against it= Short the EFP
· Wait for the market to trade thinly on Comex, like when the floor closes or between U.S. close and Asia open
· Sell the market sloppily with light volume
· Trigger sell stops
· Buy OTC swaps from another dealer after the dump, or cover shorts when stops go off.
Point is, if you have a huge position and a bigger balance sheet (or lever-ability) than your counterparties do, you are enticed to play the pot-odds game. Wait for your counterparty to be spread thinly. Look for resting stops in yours or another dealers book. Gun for them when no-one is looking. It’s a waiting game for bullion dealers. They put it on, MTM how they want, and wait for an opportunity to game the market for exit purposes. Their bankroll management consists of going to the Fed window for more money. No real market risk. Too much is determined by the ethics of the individual trader. But in a profit driven culture, errors in judgment quickly become denial, become TBTF, become, “Fuck it, I’m already up to my neck, shoot the moon.”
I know of at least one hedge fund that tried this game with ICE-NMX oil spreads and got killed. The position snowballs while you look for an exit strategy. He didn’t have a balance sheet or a storage facility and had to fudge things for months about his position until it blew up in his face.
What would be interesting is what would happen if GLD were exchangeable in EFP fashion with Comex Gold. We won’t discuss that yet because we are putting on our own spec trade in anticipation of that cross fungibility. But if you are looking to stir up the LBMA , that would do it. GLD would suck up the Comex vaults I think. There would be a lot less metal available for lease. Stay tuned, Google is my friend and I have work to do.
Gold Technicals: The market remains in a bear turnover, calling for selloffs to weekly retracement support resting at 118090*. Despite Tues-Wednesday’s recovery, trade favors follow through selloffs. We may see corrective action in the low 1200’s, but rallies contained within Tuesday’s range should maintain bear trend forces. A pop over 121510 stops aggressive bear forces, but only a close over 121610 signals for a multi-day recovery. A close under 118090 alerts for selloffs below 1160-.
Silver Technicals: The market remains in a bear turnover and signals for selloffs to drive against the 1723 early June swing low. The bear formation also warns for a larger sliding decline to 16786* weekly support. A drop under Tuesday’s low should release selloffs to 1723. Any corrective rallies will likely be contained to narrow congestion just over 1800. A close over 18321 is needed to boost a sustained recovery to test 18761* resistance. Techs courtesy GRI.
August gold was down 7.2 to $1202.6 per 100 troy ounces as of 7:18 AM EST, this morning. The September U.S. dollar index was up .308 to 84.460. October platinum was down 7.2 to $1526.0 per 50 troy ounces. Silver was down 9.8 cents to 17.975.
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