It is exceedingly easy to follow everyone else and assume that gold prices are reacting to some ephemeral change in convoluted perceptions of attitudes for expectations toward a monetary stance, but since the beginning of the year gold has been captured as a means to foster interbank liquidity. Gold prices rise when the physical shortage asserts itself, because it is a fact of the market. However, gold falls when called on by the banking system to fill in the growing repo and collateral cracks. It is that simple, and attempts to divine other causes are typically ideologically loaded.

It appears we have just concluded the third full episode of this yin and yang. Each and every gold smash is predated by a significant rise in GOFO (the effects on gold price through leasing and collateral are explained here). This latest episode was no different, except with the certainty by which gold detractors held its demise.

After spending 39 trading days below 0.00%, 1-month GOFO moved out of the negative on September 2. That move upward actually began a week earlier, coinciding with the return of negative repo rates in not just the 10-year but also other maturities. Sure enough, gold prices that had been “celebrating” the obvious shortage quickly began to reverse (again).

ABOOK Oct 2013 GOFO

That downward trend in prices lasted until a low on October 15 (AM fix) of $1,255, coming close the year’s low point. However, GOFO began to precipitously drop in the days before that, actually hitting 0.00% (1-month) on that same day. Not coincidentally, gold has moved sharply higher since GOFO turned negative once more.

As much as we want to assign other fundamental interpretations to gold prices, particularly this year with gold bears convinced of its “bubble”, there are more powerful technical factors that caution against such broad generalizations. Again, three episodes of collateral issues, three gold smashes – all preceded by rising GOFO. Once forward rates drop back and signal the shortage, prices react accordingly. Rinse, repeat.

Given that collateral remains a primary liquidity problem even in October 2013 (nothing has been fixed in funding, despite other manipulated appearances) I have no reason to suspect we won’t see the same cycle repeat again. That would suggest, and highly so, that gold prices won’t see a sustained breakout until some resolution occurs in collateral markets, or the desire for true “tail risk” insurance overwhelms this entire affair (as it did intermittently in 2008, and then all of 2009-11).

 

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