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PRECIOUS metals clawed back some losses after another heavy sell-off in Asian trading hours, as traders took stock of the abrupt unwinding of a record-breaking rally.
Spot gold was down by about 2.5%, after tumbling 10% earlier, extending its biggest slump in more than a decade on Friday. Silver also eased, after sliding 16% earlier and posting a record intraday drop on Friday.
Precious metals had risen to record highs that shocked even seasoned traders. An already-scorching rally accelerated sharply in January, as investors piled into gold and silver on renewed concerns about geopolitical turmoil, currency debasement and threat’s to the Federal Reserve’s independence. A wave of buying from Chinese speculators added froth to the rally.
“The bottom line is that the trade was way too crowded,” said Robert Gottlieb, a former precious metals trader at JPMorgan Chase & Co. and now an independent market commentator, adding that a reluctance to take further risks would constrain market liquidity.
The trigger for Friday’s dramatic selloff was the news that US President Donald Trump would nominate Kevin Warsh to lead the Fed, which sent the dollar higher and undercut sentiment among investors who had bet on Trump’s willingness to let the currency weaken. Traders regard Warsh, later confirmed as the nominee, as the toughest inflation fighter among the final candidates, raising expectations of tighter monetary policy that would underpin the dollar and weaken greenback-priced bullion.
“Most buyers who were already sitting on profits had one foot out the door, ready to exit at any moment,” said Jia Zheng, head of trading at Shanghai Soochow Jiuying Investment Management Co. The selloff has been driven largely by bullion-based exchange-traded funds, as well as leveraged derivatives, he said.
Gold and silver had already been bracing for extreme moves, as soaring prices and volatility strained traders’ risk models and balance sheets.
A record wave of purchases of call options — which give holders the right to buy at a pre-determined price — set the the conditions for a squeeze, when dealers rush to hedge their positions by buying the underlying asset as prices move higher, contributing to further price moves. When prices fall, that process swings into reverse, with dealers selling their hedges.
Many investors had piled in with leveraged bets, further reinforcing the cascade of selling. Along with margin calls on speculators who held futures contracts, exchanged-traded products such as the two times leveraged ProShares Ultra Silver, known by its ticker AGQ, amped up the rally on the way up and had to quickly unwind billions of dollars of silver positions to reflect the new lower value of their holdings, putting further pressure on prices.
The rebalancing of the AGQ on Friday to reflect the new value of its assets led to an estimated $4 billion in sales of silver futures, said Ole Sloth Hansen, head of commodity strategy for Saxo Bank A/S.
“Fundamental changes played only a minor role in the recent developments,” said Dominik Sperzel, head of trading at Heraeus Precious Metals. In silver, “limited market liquidity and high leverage significantly amplified the downward momentum,” he said.
The extent to which Chinese investors buy the dips will play a key role in determining the direction of the market from here. While the Shanghai benchmark price extended losses after the market opened, it was still trading at a premium over the international price. Over the weekend, buyers flocked to the country’s biggest bullion marketplace in Shenzhen to stock up on gold jewelry and bars ahead of the Chinese New Year.
“The combination of heightened volatility and the proximity of the Lunar New Year will prompt traders to trim positions and reduce risk,” said Zijie Wu, an analyst at Jinrui Futures Co. At the same time — particularly in peak buying season — the pullback in prices is likely to support retail demand in China, he said.
In recent years central banks have piled into gold, valued as a reserve asset partly because it cannot be frozen by hostile powers. Their purchases helped kick off bullion’s multiyear streak of gains, although they were eventually overtaken by retail and other institutional investors as the most important players in the market. Still, the presence of large determined buyers reassures some investors that there is a stable source of support for prices.
“Gold’s thematic drivers remain positive,” Michael Hsueh, an analyst at Deutsche Bank AG, said in a note. Current conditions “do not appear primed for a sustained reversal in gold prices,” he said, reiterating a target price of $6,000 an ounce.
For silver, the extent of the pullback took it below $71.66 an ounce — the level at which the white metal ended last year. Waves of hot money in China have contributed to domestic supply tightness, but that may subside as the rout damps investment demand, Wang Yanqing, an analyst at China Futures Co., said in a note. “Once the consensus expectation of a one-way rally is broken, shorts’ willingness to make delivery will increase, helping to ease the shortage,” he said.
Gold was 2.5% lower at $4,771.85 an ounce as of 11:38 a.m. London time. Silver lost 1.4% to $83.99. Platinum and palladium also retreated. The Bloomberg Dollar Spot Index, a gauge of the US currency, was flat after rising 0.9% in the previous session. –BLOOMBERG
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