02 October 2011

Futures furphies

Wikipedia: A furphy, also commonly spelled furfie, is Australian slang for a rumour, or an erroneous or improbable story.

In Gold Stocks: Ready, Set, Eric Sprott and David Baker say that "While the futures market is comfortably forecasting a continuation of today’s levels, the majority of sell-side analysts refuse to update their gold price estimates to reflect its recent strength."

It is futures 101 that futures prices are not a forecast by the market, they are just a mathematic derivation from the spot price, interest rates, freight and storage costs, with gold interest rates and dollar interest rates being key components. Backwardation is when gold interest rates are higher than cash rates. Contango is the reverse. Either way, the futures price isn't forecasting anything. See this blog post for more on backwardation.

In that same article, Sprott raised the "excessive turnover" meme which Eric seems to be running recently - he must think he is on a winner with this. I dealt with it in this post and to that I'd like to add another counterpoint. First, the quote:

"In the LBMA market, for example, market participants traded an average 19.6 million ounces of gold PER DAY in July 2011. Keep in mind that the total gold mine production in 2010, globally, was approximately 86.5 million ounces. ... so the LBMA is essentially trading a year’s worth of production in less than a week"

I think it is misleading to relate turnover only to new mine production. This assumes that there is no sales by any of the investors who hold above ground gold. Eric should at least be including privately held gold stocks of 30,000t, or 965 million ounces. Adding that to the 86.5moz then the 19.6 moz represents the "LBMA" turning over the stock once every 54 days, or 7 times a year. Not as dramatic, is it. If we included the 30,000t or so of central bank holdings then it is even less so. But don't fear Eric, help is at hand.

The funny thing about the "large turnover is bad" idea is that in most markets this is seen as a good thing, as it indicates the particular market is liquid. On this line of thought, note that the recent Loco London Liquidity Survey was undertaken by the LBMA at the request of the World Gold Council "in order to strengthen its argument that the gold market is sufficiently deep and liquid to justify gold’s characterisation as both high quality and liquid" with the objective of getting gold included in the Basel liquidity buffers for banks.

What did their survey show? "The average daily trading volume in the London market in this period was 173,713,000 ounces or $240.8 billion." I can see Eric getting his calculator out now and dividing 86.5 by 173.7 and getting really excited. When you hear that the "paper" markets turn over annual mine production every 12 hours, remember you heard it here first.

The other thing I find interesting is the different way Sprott pitches this meme. For the gold/silver bugs we get:

"... I think all the paper markets are a joke. As you are probably aware, we trade a billion ounces of silver a day. A billion ounces. The world produces 900 million a year." (link)

But in the Markets at a Glance article with Sprott branding on it for a more wider market it is less breathless and a bit more sophisticated:

"When price discovery is dictated by levered paper contracts with no physical backing, it’s extremely easy and relatively inexpensive to jostle the spot price around."

Interestingly, the LBMA survey revealed that 90% of trading was spot, not forwards (sort of the over the counter markets version of futures), which equals 156moz. COMEX average daily trading during August was 278,000 contracts, or 27.8moz. 156 versus 27.8 - who do you thinks jostles who?

Continuing on with futures, we get this from Patrick A. Heller: "Increases in margin requirements make sense as prices are rising, as that helps keep the market in order, but it does not make sense when prices are falling."

Now this is a very common misunderstanding. Margin increases (or decreases) are to do with volatility of the price, not the direction of the price. Dan Norcini explains it well:

When you get a market like silver that drops 15% in ONE DAY, you are going to get margin hikes. The reason - the very integrity of the Clearinghouse comes into play.

Silver closed down $6.48 today. In a single session, one long contract in this market cost the buyer a paper loss of $32,400! That is enormous. If you consider the fact that the previous old margin was $21,600, that was wiped out and then some.

During the clearing or settlement process, the winners get paid (have their accounts credited) by debiting the loser's accounts. If the losers do not have sufficient funds in their accounts, the whole process breaks down.

Zero Hedge has really went downhill in the past few years and this post by them I found very funny and symptomatic of the sort of readers they are now attracting:

We are only putting this up because we have been flooded with emails about an event which for some reason readers believe is relevant. The event in question is that according to its website, the London Gold Exchange ("LGE" or the "Joke") has closed. The one thing we would like to say about this is that the LGE is nether an exchange, nor does it trade gold.

You have only yourself to blame Tyler. While he didn't meant he post to be ironic, I read it that way. Yes, Tyler, your readers can't tell between real gold news and rubbish, but guess what, neither can you, IMHO.

To close, I'll quote myself from Ed Steer's Gold & Silver Daily on the recent sell off in precious metals:

Here's an interesting comment that I got from my friend Bron Suchecki over at The Perth Mint yesterday. I'd sent him an e-mail on the weekend asking him how sales were both on Friday...and their Monday, which started Sunday night here in North America. This was the reply that I got...

"The Perth Mint has been very busy this Monday morning with a lot of buying [but also some selling], however buying is outweighing selling by a fair margin [pun intended]...and the decrease in the AUD/USD has taken some sting out of the drop for Aussie investors.

I see this sell-off driven by leveraged “weak hand” money. In contrast, average investors [the real smart money] are looking at this as an opportunity to buy in or top up at cheaper prices. These buyers are “strong hands” and have been the ones who have been driving the trend all these years."


  1. When they say 'spot' don't they mean LBMA allocated accounts?

    So spot is not really physical, there must be a customary minimum that trader Joe or institution X has to wait for their tonnes of gold? In the meantime there is a liability on someone's books?

    Of course no one my be 'taking delivery' at all.

  2. Also, since when has it been commonly spelt furfie?

    I don't trust this Wikipedia, I wonder what they say about silver manipulation?

  3. Spot in that context means unallocated. There isn't really a minimum to convert that to physical, but normally you're talking about 500kg or a few tonnes.

    Some traders may not take delivery, but for the Mint and other end users the unallocated accounts are turned over into physical regularly.

    The LBMA survey showed that turnover to clearing ratio was 10:1. I don't think it was coincidental that Mr Christian confirmed the fractional ratio at 10:1 here http://goldchat.blogspot.com/2010/04/london-unallocated-fractional-fubar-or.html

    Clearing represents the net settled trading, in some sense the "real" trading.

  4. Norcini better be careful or he'll get kicked out of the gang and Eric King won't interview him anymore. ;-)

  5. ZH has gone downhill?

    The post you reference seems to be contrary to that, since it was informing readers to STFU about the bogus London Gold Exchange.

    I am a regular reader of ZH, and I find their reporting on the media distortions, politician's lies, market dislocations and growing problems (leading to subsequent crises) top notch.

    Sure, many of the comments are less than useless (although not all), but I'm not sure why you think that's an excuse to steer your readers away from what is arguably the best source of actionable news on finance.

  6. By customary minimum I meant minimum time not ounces.

    Spot as unallocated would seem to leave a lot of room for 'fractionalisation', no?

    Can you elaborate on this 'turnover to clearing'? I don't see that physical need be involved, unless by turnover you mean gold account into physical gold.

  7. The state of ZH deserves a post on its own. Their knowledge of the gold market leaves a lot to be desired.

    For physical users it isn't really about time, you only accumulated unallocated until it reaches an economic size for shipment - you aren't going to ship 10kg for example.

    By turnover to clearing what I meant was that turnover represents the same ounce trading many times during the day, but the clearing numbers represent the "real" net settled metal that exchanged hands for that day.

    Yes clearing volumes are not necessarily 1:1 with physical due to fractionalisation of London unallocated, but they are also not totally paper either.

  8. So instead of slamming them for being ignorant on some aspects of gold, why not instead send them a guest post enlightening them?

    And while they may get that wrong, what about the rest of their reporting? Gold is only one of dozens of topics they cover. Why offer a blanket commendation, especially when most of their predictions have been spot on?

  9. Hi Bron,

    Is there any part of this you would disagree with, it just seems like common sense....


    Also, what do you think of the way gold was smashed just prior to the Swiss National Bank Euro peg announcement, surely that was central bank manipulation??

    I just want to get a sense of whether you believe their is any covert nefarious intervention in the gold market.... quite frankly, your credibility hangs on it IMO.

  10. Dave, you can't be serious. Have you seen how their readers respond to anyone questioning what has been posted.

    Compared to three years ago, the quality of the insights has declined and they do a lot more regurgitated content from other non-anonymous commentators. That doesn't mean that content on financial stuff isn't good, its just that ZH's scoops, insider leaks and original content is now very weak compared to what they started out as.

    I will do a post about ZH and then you'll see the depth of the problem.

    trevbus - we have seen a lot of physical retail demand at these prices, so I concur with that.

    Do central banks "manage" gold. Of course. I am amazed that GATA has wasted so much time tying to prove this when it is so obvious - why else to CBs hold gold as a reserve along with paper currencies. They "manage" interest rates, explicitly intervene in FX markets, so why would gold be treated differently? GATA would have been far better off taking this as given and spending their time asking the question "should they be in the gold market" (I've got a post on this in the wings).

    My big problem is statements like "So the Western central banks got together, leased out some gold and the bullion banks sold the gold". That is comic book level of intelligence. This sort of simplistic conspiracy comes from the fact, IMO, that those who write it have limited knowledge of how the precious metals markets work so their theories of what is going on is painted in big primary colours like a schoolkid. The market is a dynamic system and the games that can be played can therefore be far more sophisticated. The problem in explaining this is that the reader need a good understanding of the relationships in the "system" to get it. Partly why I started this blog to up that understanding, but far more work to do in that regard than I have at the moment.

    I have lost a bit of motivation to do it considering that few actually want to understand and are happy with the simplistic pictures presented to them as they validate their decision to buy precious metals, and that validiation is I think all that most people are after. The smart bloggers realise that providing this gives them the pageviews and thus advert money and so they keep it simple and stretch the truth and sometimes make up stuff. Ultimately I think ZH realised that most readers didn't want intelligent thought out stuff and so just went for the mass market.

  11. "Dave, you can't be serious. Have you seen how their readers respond to anyone questioning what has been posted."

    Bron, I seriously hope your not judging a blog by some of it's commentators. Granted, some are morons, but there are also more than a few who are extremely insightful, and are more than mindless bashers.

    "Compared to three years ago, the quality of the insights has declined and they do a lot more regurgitated content from other non-anonymous commentators."

    I strongly disagree, and quite frankly, only someone who hasn't read the blog lately would state that.

    "That doesn't mean that content on financial stuff isn't good, its just that ZH's scoops, insider leaks and original content is now very weak compared to what they started out as."

    Again, I strongly disagree.

    "I will do a post about ZH and then you'll see the depth of the problem."

    Great - But please be sure to use some recent examples.

    "Ultimately I think ZH realised that most readers didn't want intelligent thought out stuff and so just went for the mass market. "

    Are you serious?

    Bron, do you honestly think the average Joe is interested in topics such as "Doubling Down To (DXY) Zero: Has The Fed, In Its Stealthy Synthetic Bet To Keep Long-Term Yields Low, Become The Next AIG?"?


    I hope you'll admit that 99.99% of the public *couldn't begin to understand* that article, let alone be *interested* by it (I was interested, but still only partially understand it!).

    If you wanted, I could easily give you a hundred more deep-diving examples like that.

    I look forward to your article.

  12. Bron,

    "I have lost a bit of motivation to do it considering that few actually want to understand and are happy with the simplistic pictures presented to them as they validate their decision to buy precious metals"

    There are a load of people who rely on your honest debunking, and it is critical IMO. There is little transparency in PM's so I for one, and I know others really value your posts.

    On ZH, I got led down the garden path by them on so many occasions when I first started my gold research, so I use them for headlines, and they are often right on non PM issues, but I'm very wary on any PM posts from Tyler.

    I have a friend in a NY IB, and they use ZH, and this is a quote "you'd have to hide under a rock if you believed all they say", but they do use them for chasing the validity of some posts.

    I'm not saying ZH is not worth looking at, but for PM's no one can really be sure what's going on due to the opaque nature of the trades, so you can't make assumptions like ZH often does.

    Regardless of what the FED or anyone else says, gold is used as a financial asset by the BIS and all it's CB's. Weather you call it money or not is irrelevant as it's used exactly like money by the CB's, and increasingly by others like CME, and in certain trades.

    Anyway Bron please keep the faith.

  13. Dave,

    I may be able to concede with respect to financial markets stuff, but my comments completely apply to precious metal content on their blog. In fact I don't remember they did much on PMs early on, only in past few years they really got on the PM bandwagon.

  14. Trevbus said:

    "I just want to get a sense of whether you believe their is any covert nefarious intervention in the gold market.... quite frankly, your credibility hangs on it IMO."

    Trevbus, Bron has far more credibility then ANY of those PM pumping conspiracy entrepreneurs that view every decline as a product of manipulation. Do you know anything about market structure and the impact of systematic hedge fund trading, which dominates the market? Have you ever thought about deflation and how that may impact the PM markets? Have you ever thought about the impact margin induced selling of other assets can have on PM markets?

    I suggest you think a little before questioning the credibility of a veteren of the precious metals industry who has given us the benefit of his deep knowledge of the industry with balance and without the unnecessary hype and misinformation posted daily at all the other blogs.

  15. Bron, an anonymous lurker here. I want to tell you that You must write that post on the Gold market precisely because most people don't understand this market! You'll be doing a great service to many. You are unique because you are an 'insider outsider' in this space - you have inside knowledge of the complex workings of the PMs market and an ability to relate this to others who don't have the experience you have. Admittedly, there will not be many people who will be interested and able to grasp the whole thing, but that should not dissuade you. After all, if the average IQ is 100, there can only be a small number of people in the higher brackets, that's a statistical tautology. So please, don't give up, write that piece on the complex workings of the PMs market.
    On ZH, you are right that their posts on PMs are not worth reading much, but overall they are an excellent counterpoint to the mainstream media. And we ought not to judge ZH by its readers' comments. Tyler has 'Fight Club' as his motto and has a deliberate policy of not editing or moderating the comments at all, which is brave in the blogosphere. These days I only read most of the synopsis, some of the posts in full, and almost never read the comments. There are a lot of disturbed people out there who find full expression on ZH. But that does not detract from ZH's posts, especially in the banking/finance/govt areas.
    Returning to the main point: Please write the full monty on the Precious Metals Market. I for one have been dying to understand it for years.

  16. Brian O'Flanagan,



  17. ZenfxTrader,

    Google put you into my spam folder, no idea how it works because it leaves obvious spam comments with links to dubious blogs.

    Anyway, I also have a deliberate policy of not editing or moderating the comments but don't seem to get the crap which is probably because there is no rah rah rah stuff here.

    Insider Outside is a good way of putting it. Perth Mint is by virtue of its government ownership and refining volumes linked into the markets but because we are not a central bank, a bank or willing to get involved in risky activities, we aren't in the big boys club.

    As a result, I am an outsider but with enough knowledge of the business to have a guess what the insiders get up to. I just need time to put that together into a coherent and solid post, I don't want to go half arsed on this as I know it will get attacked.

  18. Just a thought I've had, if 'spot' gold is unallocated bullion bank metal, wouldn't a more accurate measure of backwardation be any premium on the bid on say, Perth Mint allocated compared to the bid on NY or London 'spot' & forget futures?

  19. Justin, the thing is that the Perth Mint's spot (for physical) is based off the unallocated price because we can get physical at that price.

    If/when people don't want unallocated, or bullion banks won't give us physical for it, then yes we will be quoting/making our own price for physical.

  20. Yeah, I didn't say there is currently a premium but comparing the two bids would give you a better indication of backwardation since futures are not generally used for acquiring physical gold, rather just to scalp a profit in dollars on a rising gold price, or alternatively shorting to profit on a falling gold price.

  21. To state it another way, Perth Mint's spot price is the ask. If the bid for Perth Mint spot was higher than the Perth Mint's bid for bullion bank unallocated, then backwardation?

  22. Yes but we wouldn't be showing such a diversion, just quoting our prices for physical.

    I'd certainly let you know if that happens, and probably before it does because the unallocated for physical would start to seize up first. Don't worry, I'll tell you when the paper price actually does diverge from physical.