Gold Options Skew Market

Posted: May 03, 2012 12:01 AM

Gold was down again yestreday morning, steadily drifting back towards the more comfortable $1,640 range.  At least the price movements are in line with moves in the currency markets as the euro keeps losing ground to the dollar. 

In early trading gold was down $11.05 to $1,651.10 and silver wasoff $0.37 to $30.63, leaving the silver/gold ratio at 53.9, where it was the day before. 

The pricing movements this week point out the inflation and volatility induced in commodity markets by derivatives trading, the same kind of market manipulation the equities markets have experienced for the last decade. 

This week the gold market was shaken and trading briefly halted because of a single order.  Gold fell $14 an ounce in one minute on April 30 and trading was halted when someone fat fingered a sell order worth $1.24 billion dollars.

Most analysts agree the order was either a mistake or deliberate market manipulation.  If you know there are a lot of stop-loss orders at a particular price point and you have the means to induce a big move in the market, you can create a cascade crash in prices with a large sell order by triggering programmed trades.  When the market crashes, you can then buy back in at a huge discount and pocket the difference when prices recover.  That’s nice work when you can get it. 

So what’s happened this week is that we had the huge panic crash, an almost immediate recovery in prices, then a gradual sell off down to almost the exact same level as the flash crash.  All of those moves were taking place apart from fundamentals like currency exchange rates.  That’s quite a coincidence, isn’t it? 

Now you know why I constantly prod my readers to buy physical gold and silver and avoid bullion-backed instruments like ETFs.  But if the precious metals market is inflated by derivatives trading, doesn’t that mean there’s the chance gold prices would collapse if the market collapsed?  Absolutely, but so what? 

The gold and silver you have in your safe is going to retain some relative value regardless of what happens to the market and prices will naturally correct to some equilibrium relative to currency values.  And that is why you keep physical gold in your safe instead of a bullion-backed ETF in your portfolio. 

Chris Poindexter, Senior Writer, National Gold Group, Inc