Guest post by Henry Bonner (firstname.lastname@example.org)
Sprott Global Resource Investments Ltd.
Last week gold fell profoundly from $1,580 to $1,350 in a few short
days, rattling many investors. This week we are seeing a determined
rebound and many are searching for the cause of such a dramatic price
action. I asked Investment Executive Eric Angeli at Sprott Global Resource Investments Ltd. for his outlook on the yellow metal.
“My outlook remains bullish,” he begins, “no one knows if the price
of gold will come back tomorrow, if it will take months or even longer,
but I think those who remain long the trade and especially those with
the courage to add to the trade will be greatly rewarded when these
markets come back. I see nothing in the collective policies of global
officials to suggest precious metals have lost their luster as a store
of value in these uncertain times.”
What are the reasons for the biggest one-day drop in 30 years?
“On the morning of April 12th, the futures markets were
flooded by two unprecedentedly large trades – 100 tons hit the market
and an hour later, another 300 tons hit. Who has that much gold to sell?
Why is this such an abnormal event?
“Traders typically spread large sell orders over time. That way, they
avoid flooding the market all at once and causing the price to decline.
An experienced trader would know that a sell order of that magnitude
would be likely to crush the price; unless, of course, that was the
objective.” He adds that the massive 400 ton trade was likely made on
leverage, meaning that the trader who made it had only put up enough
money to cover between 5-15% of the order. “In highly leveraged markets
like futures exchanges, individuals can cause large price movements with
relatively little net exposure.”
As Eric explains, the morning after a massive drop is when margin
calls are sent out requiring those who are investing with leverage to
post more cash to meet the cash call. “This will amplify the drop as
selling has a tendency to beget more selling in a bear market. When the
value of the assets that traders buy on margin declines beyond a certain
level, they are forced to sell off some of those assets in order to
cover their margins. We witnessed compounded selling in nearly every
equity space, and gold and other commodities were no exceptions.”
Gold’s increasing role as collateral for foreign banks adds to the
snowball effect, says Eric. While he believes this further validates
gold’s role as money in the international community, the price drop
meant that the value of the gold collateral declined enough to drive a
cash call – which often results in these banks having to sell off some
of their gold.
In addition, the Shanghai Gold Exchange recently announced it is
increasing its margin requirements to 12% for gold and 15% for silver.
The Chicago Mercantile Exchange announced last week that it would
increase margin requirements for gold and silver contracts by 19% and
This is important because “traders have to put up more cash to make the
same sized trade, and many will have to sell to meet those margin
requirements, or at least reduce their investing ability overall.”
Finally, this type of selling is often to be expected in the later
phases of a down period: “Right now is the time when weak investors exit
the market – when sentiment is at its lowest. I believe that precious
metals’ fundamental strength remains intact as much now as ever before.
Successful investors are defined not by what they do in a bull market
but by their boldness in bear markets. The successful investors of
tomorrow will be those that seize the opportunities of today.”
Eric Angeli has been with Sprott since 2006, when he moved from
major Wall Street firms Morgan Stanley and Bear Stearns to work under
the tutelage of Rick Rule in the natural resource space. Eric takes a
concerted interest in the education of his clients and is an avid
proponent of the value-based investing strategies of Benjamin Graham.
Eric holds a double major in finance and international business from New
York University’s Stern School of Business. To contact Eric, e-mail him
at email@example.com or call 1.800.477.7853.