Memorial Archives

USD Price Action and Gold COT
posted Apr 4, 2004 at 08:38AM

Call me cynical but I was not surprised about the positive jobs report. It was good because it "had" to be good. I had the feeling that another bad jobs report like the one before it, would have had currency markets convulsing.

A lot of leveraged bets got caught leaning the wrong way.

Given the horrid fundamentals of the USD one has to wonder how much follow through there will be. It IS coming off historically oversold levels and a breach of the secondary channel says 200dma will be breached which may get more technical momentum going.

The Gold COT shows speculative interest at dawn of creation highs. Now the past three years have shown that the charts are more important than open interest...but at these levels I still find it hard to make big bets.

I quote some passages from an excellent article, "The Markets Are Leveraged to Crash" by Richard Benson on,

"What happens when investors want to reduce their risk and need to sell but can't find a buyer? The old story from the stock market crash of 1929 comes to mind about an investor who kept buying a stock from his broker that continued going up in price. Finally, the investor asked his broker to sell. The Broker responded, "Who am I supposed to sell the stock to? You're the buyer!"

That is why the elephants like Warren Buffet and other smart players are already in cash! You can sell a few million dollars worth of stock without rocking the market too badly. But, can you imagine what might happen if some really large hedge fund or Wall Street firm wants to unwind a small $100 billion of levered "cash and carry" trade in mortgage securities. What if a few hedge funds decided to sell a measly $500 billion in mortgage securities? They would be trapped because the markets are just not that liquid, especially when everyone wants to sell! That's why it's important to be in cash before the crash!

The situation today could be much worse than 1929. In 1929, the major fault in the financial system was stock market leverage. In the 1920's, stocks could be bought with 10% down! Those who waited to sell stocks were crushed. Stock prices triggered margin calls and forced them to sell. This is not a virtuous cycle; it's called de-leveraging and it causes a crash. Paying off debt reduces the money supply. [Money is borrowed into existence and paying down debt destroys money].

The problem for our financial system is that in many asset classes, the leverage is extreme. In order to run a leveraged position in mortgage-backed securities, a firm may only need 5 percent equity and can run leverage at 20 to 1. This leverage is way beyond the leverage that crushed stocks in 1929 to 1934. A small rise in short-term interest rates is all that is necessary to trigger a sale of mortgages and treasuries by financial institutions. With respect to bonds, a 5 percent fall in prices is not major and can occur very quickly. Unfortunately, a 5% fall in bond prices could wipe out 100 percent of a financial player's equity!"

The one point I would add is tha above applies equally well to the gold market as well as equity markets. If some large hedge funds decide to bail, and given the ratio of longs to shorts among large and small speculators, it could get equally ugly in that arena as well.

Don't kid yourself...a lot of the players on the COMEX market are leveraged up to thier ears.

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