According to the most recent report on the U.S. Financial Institutions Derivatives trading activity, the U.S. banks held a record amount of precious metals contracts in the first quarter of 2017.  Not only did the U.S. banks report a record amount of precious metals contracts, they also held a record amount in notional value of commodity and equity derivative contracts.

There just seems to be a lot of paper floating around in our highly inflated stock, bond and Forex markets.  And… there needs to be.  Without an ever increasing amount of leverage via their derivative bets and hedging, these markets would be in serious trouble.  Furthermore, the practice of using contracts to hedge bets upon on other derivative bets has put the financial market in a highly fragile state.

The Office of the Comptroller of the Currency (OCC) put out their First Quarter 2017 Quarterly Report on Bank Trading and Derivative Activities.  In that report, they published the following chart on the U.S. Banks notional value in precious metals contracts:

As we can see in the chart, the overall trend has continued higher since 2000.  What is interesting is that the notional value of precious metals contracts held by the U.S. banks is even higher in the first quarter of 2017 versus Q4 2012 when the prices of the precious metals were much higher.

In looking at previous data, there were some quarters that had a higher notional amount of precious metals contracts.  This was due to the banks adding short contracts as the price of precious metals increased.  However, Q1 2017 of $43.6 billion was up considerably versus the $28.3 billion in Q1 2016. 

For example, in Q3 2016, U.S. banks also held $43.6 billion in precious metals contracts.  Again, this was due to a lot of short contracts held by the U.S. banks when the gold price surged to a high of $1,366 in the third quarter of 2016.  As the gold price sold off over the next several months, the precious metals contracts declined in the fourth quarter of 2016:

We can see this in the last bar on the chart on the right.  But what is quite interesting is the big increase in U.S. banks precious metals exposure in the first quarter of 2017, shown in the first chart above, when the amount of short gold contracts the large U.S. banks held declined significantly in the chart below:

Now, this is only showing the U.S. banks gold contracts.  This does not include other precious metals, such as silver, platinum and palladium.  However, gold is by far the largest market.  If we include the FX contracts (forward exchange contracts), the total notional amount is enormous:

The total notional amount of U.S. banks FX & Gold Contracts was a stunning $34.5 trillion in the first quarter of 2017, up from $30.7 trillion at the end of 2016.  Here is the definition of a Forward Exchange Contract by Investopedia:

Forward Exchange Contract: A forward exchange contract is a special type of foreign currency transaction. Forward contracts are agreements between two parties.

Forward contracts are not traded on exchanges, and standard amounts of currency are not traded in these agreements. They cannot be canceled except by the mutual agreement of both parties involved. The parties involved in the contract are generally interested in hedging a foreign exchange position or taking a speculative position.

The nature of forward exchange contracts protects both parties from unexpected or adverse movements in the currencies’ future spot rates.

So, these FX Contracts are hedges on different fiat currencies spot price movements.  We don’t know what percentage is hedged in Gold or FX contracts.  However, I would imagine the majority being in the FX Contracts that are hedging the different fiat currencies.

Now, what is also quite interesting about the huge increase in the FX & Gold contracts notional values, is that global GDP hasn’t really increased that much since 2013.  According to the World Bank, here are the global GDP figures over the past four years:

Global GDP (current U.S. Dollars)

2013 = $76.9 trillion

2014 = $78.9 trillion

2015 = $74.5 trillion

2016 = $75.5 trillion

If we divide the notional amount of FX & Gold Contracts by the global GDP, we can see a very interesting trend:

FX & Gold Contracts Notional Amount Divided By Global GDP

2013 = 28%

2014 = 32%

2015 = 40%

2016 = 41%

What we have here is a great deal more FX & Gold paper amounts trading versus the global GDP.  In 2013, the FX & Gold notional amount by the U.S. banks accounted for only 28% of global GDP, however it jumped to 41% in 2016.  I would imagine in 2017, it will be even higher.

While the notional amount of FX & Gold contracts has hit a record high, take a look at the next chart:

These two charts display the amount of “Commodity” and “Equity” contracts in notional dollar figures held by U.S. banks.  While there was a temporary blip in 2005 (mostly longer dated contracts – in BLUE), there was a pronounced increase in 2015, 2016, and 2017 in both of these derivative asset classes.

According to the data by the OCC, the U.S. banks held $1 trillion in commodity contracts and $3 trillion in equity contracts in the first quarter of 2017.  While these figures are much less than the FX & Gold contracts, they have still increased substantially over the past three years.

For example, in 2014, the U.S. banks held $431 billion in commodity contracts and $745 billion in equity contracts.  In just three years, the U.S. banks exposure to commodity contracts has more than doubled to $1 trillion and their notional amount of equity derivatives has quadrupled to over $3 trillion.

Again…. the U.S. banks are holding onto a record amount of paper derivative contracts in these different asset classes.  Yes, it makes some sense that the U.S. banks equity contracts are increasing right along with the rising highly-inflated stock market, but to see the commodity exposure double when the prices of most commodities are much lower than what they were before 2014, is quite interesting:

As the commodity index above fell from over 300 in 2014, to 176 currently, the amount of U.S. banks exposure to the commodity market has more than doubled to $1 trillion. Unfortunately, I don’t know all the particulars as to why the U.S. banks have increased their exposure to such a large degree in these different asset classes.  However, to see a record amount of paper trading in a market that is already highly leveraged… points to big trouble ahead.

Check back for new articles and updates at the SRSrocco Report.

Yesterday, the minutes of the Federal Reserve’s July meeting were released. What do they say about the Fed’s stance and what do they mean for the gold market?

How can we summarize the recent FOMC minutes? Well, the FOMC members agreed that “the labor market had continued to strengthen and that economic activity had been rising moderately so far this year”. But the most important discussion concerned three other issues.

First, several participants noted uncertainty about the future course of the fiscal policy. A few of them even suggested that “the fiscal stimulus likely would be smaller than they previously expected.” The declining odds of significant fiscal stimulus imply less need for a more hawkish Fed. Thus, this is a bad development for gold.

Second, the several FOMC members pointed out further increases in equity prices. They argued that the rising valuations, together with continued low longer-term interest rates, are equivalent to an easing of financial conditions. Hence, the Fed could be potentially more hawkish as its tightening of monetary policy has been largely offset by other factors influencing financial markets. This is good news for the yellow metal.

Last but definitely not least, the U.S. central bankers discussed the recent low readings of inflation. Although many of them saw the softness in inflation as caused by idiosyncratic factors and thus temporary, the FOMC members noted the downside risks to the inflation outlook. The key paragraph is as follows:

“Participants discussed the softness in inflation in recent months. Many participants noted that much of the recent decline in inflation had probably reflected idiosyncratic factors. Nonetheless, PCE price inflation on a 12 month basis would likely continue to be held down over the second half of the year by the effects of those factors, and the monthly readings might be depressed by possible residual seasonality in measured PCE inflation. Still, most participants indicated that they expected inflation to pick up over the next couple of years from its current low level and to stabilize around the Committee’s 2 percent objective over the medium term. Many participants, however, saw some likelihood that inflation might remain below 2 percent for longer than they currently expected, and several indicated that the risks to the inflation outlook could be tilted to the downside.”

Hence, the recent minutes showed rising worries about inflation. Therefore, the U.S. dollar fell after their release (however, it rebounded today against the euro), while the shiny metal rose, as one can see in the charts below.

Chart 1: EUR/USD exchange rate over the last three days.

Chart 2: Gold prices over the last three days.

To sum up, the July FOMC minutes were released and they were generally a bullish event for the gold market. The reason is that they showed the increasing worries about the recent softness in inflation. Although most of the FOMC members still believe that inflation will stabilize around the Committee’s 2 percent objective over the medium term, the size of the cautionary group is expanding. It means that the odds of a December hike are lower, which is fundamentally positive for the yellow metal. However, there is plenty of time before the December meeting, so a lot may change. Now, all eyes are on the today’s minutes from the ECB meeting in July and on the Jackson Hole conference held next week. Stay tuned!

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Disclaimer: Please note that the aim of the above analysis is to discuss the likely long-term impact of the featured phenomenon on the price of gold and this analysis does not indicate (nor does it aim to do so) whether gold is likely to move higher or lower in the short- or medium term. In order to determine the latter, many additional factors need to be considered (i.e. sentiment, chart patterns, cycles, indicators, ratios, self-similar patterns and more) and we are taking them into account (and discussing the short- and medium-term outlook) in our trading alerts.

Thank you.

Arkadiusz Sieron
Sunshine Profits‘ Gold News Monitor and Market Overview Editor

The outlook for precious metals has changed quite a bit over the last month. In early July, Gold and gold stocks were weak and threatening severe breakdowns below key levels such as $1200 Gold and $21 GDX. Those moves reversed course and now Gold and gold stocks are threatening resistance. The prognosis has turned bullish and with the help of a correcting stock market precious metals could build on their recent rebound.

Below we plot the weekly bar chart of Gold which is testing critical resistance in the $1290-$1300 area. Gold could close the week at its highest weekly close in 2017, just weeks after breaking its 2017 uptrend. That early July breakdown proved to be a false break as Gold has been able to rally back up to resistance. Gold has broken the downtrend line since 2011 but the most important resistance is $1300. With a break above $1300, Gold could be on its way to a retest of the 2016 high at $1375.

Turning to the miners, we find that GDX has already broken its downtrend and the 200-day moving average. GDXJ faces strong resistance at $34-$35. Silver has a little ways to go before it can break its downtrend line but its relative strength in recent days is quite encouraging. 

While there are only a few data points in the junior bull analog chart (which is based on our junior indices), it suggests the juniors could be close to starting a new leg higher. If Gold is going to rise to $1375 then the juniors would enjoy a good pop. The analog chart shows the significant upside potential in juniors if Gold were to clear $1375 and advance towards $1550-$1600. 

There are several reasons we have turned bullish. First, precious metals were breaking down in early July yet that reversed course entirely. Gold has rallied back to +$1290 and well above resistance at $1240-$1250. If Gold were going to break below $1200 then the rally would have rolled over again around $1240. Second, intermarket activity has turned quite favorable for Gold. The US$ index has not made a new low but Gold has perked up. Meanwhile, Gold is benefitting (as it should) from weakness in the equity market. We think the weakness could continue and drive Gold to $1375.

The bottom line is Gold is now showing strength on both a nominal and relative basis. If this continues then Gold will clear $1300 and the gold stocks (which have been lagging) could push higher in sudden and aggressive fashion. 

Jordan Roy-Byrne CMT, MFTA

Jordan@TheDailyGold.com

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