Wednesday, May 15, 2013

So Much for Position Limits on COMEX Gold

CFTC logoHOUSTON -- We are using this space to put something in the public domain out of convenience more than anything.

Where were the regulators on gold futures position limits April 12 and April 16? 

Flash back to Friday, April 12, when the paper gold futures market was slammed with an enormous sell order in the early going of New York trading, following a “tenderizing” of the market right at the New York open. 

We have read and heard various descriptions of the initial sell order being as little as 124 tonnes and as much as 400 tonnes of gold equivalent – sold by a single source or by a group all at once – with the express intent to break the gold market.  (More...)

Friday, April 12 5-minute tick chart courtesy of Ross Norman, Sharps-Pixley, UK. 

We want to voice a concern of ours which we thought of that very day and have thought about off and on since then, but have yet to act on it.  (Other than to share it with several colleagues.)

Our simple question:  Where are the regulators (in this case the CFTC and CME Group) with regard to size and accountability limits?

First, though, a caveat:  We do not have the actual trade data which would include the actual orders and the sellers of those orders.  Without that, this is pure speculation and subject to receiving that actual data. (More...)

That said, what we do know is that the volume spiked to an unprecedented level April 12 and Monday, April 15 and that initial sale triggered an avalanche of trading and trailing stops.  The net effect was that the initial order was indeed large enough and sold into the market fast enough that it literally overwhelmed the gold futures market.  Whoever it was used a bazooka at a knife fight. The selling panic that ensued will be talked about for generations.

CME GROUP LOGOWhether the initial sale into the gold market was 124 tonnes or 400 tonnes is not really material to our question.  Either size would be so much higher than any one trader should have been able to sell into the gold market at one time that it begs the question:  How many traders would have had to be involved in order to “legally” sell that many gold futures contracts into the market? 

Let’s assume for this discussion that the initial sale was 124 tonnes. That’s about 4 million ounces or the equivalent of 40,000 COMEX contracts. 

From earlier work we know that the CME Group has position limits for gold futures of 3,000 contracts in the front month and 6,000 contracts in all months.   

We know from the open interest that the initial sale on April 12 was concentrated in the front month, so no one trader should have been able to sell more than 3,000 contracts at one time, and that’s assuming that trader had a zero open position when the sale occurred.  The 3,000 number is supposed to be the limit of all contracts and options, both long and short at any time, even intra-day. 

Assuming all the traders involved had no open contracts before opening four million ounces worth, how many traders would have had to be involved?  Simple math says (40,000 contracts / 3,000 lots limit) = 13.3 traders.  Call it 14 traders. 

So, in order for the initial 124 tonne sale to have occurred “legally” it would have had to have been 14 traders, all with zero orders open, all acting simultaneously, all acting independently, in their own self-interest, without colluding with each other to “sell-for-effect” or conspiring to foment a price smash. 

In actuality, the chances that there were 14 traders who held zero open orders all acting independently, all throwing their full allowable 3,000 contracts into the gold market within a few minutes of each other are infinitesimally small.

Much more likely is that the initial sale which triggered the sell stop putsch in gold was done by a single trader, acting so far outside the position limit regime as to be brazen about it.

How about a few facts:

At the time of the large sale on April 12, the gold price was breaking through $1,520.

4 million ounces at $1,520 is roughly $6 billion in notional value. 

40,000 contracts would have required about (40,000 X $5,940) = $237.6 million in initial performance bond requirements, if the traders were Spec members.  (CME Group subsequently raised Spec initial margin to $7,040 for the close on April 16.)  If the big seller was a commercial hedge member, then it would have required (40,000 X $5,400) = $216 million in initial bond requirement.  (CME Group subsequently raised Hedger initial margin to $6,400 for the close on April 16.)

At the time of the large sale the COMEX open interest was a little over 416,000 contracts.  So the initial sale was about 10% of the entire open interest of the COMEX.  There was little change in the number of contracts open as of Tuesday, April 16, by the way (413,083). 

A few questions:

Who was the large trader who decided to hammer the gold market with 40,000 contracts all at once? 

How did that trader manage to do so without running afoul of the CME Group position limits or the CFTC regulators? 

Was the initial trade by one, two or many traders?   If by one or two, then there is no way in hell the trade was “legal” under the position limits.

If by many traders all acting at once, then how is that possible without their conspiring in advance to do so? (We are talking about the initial smash trade here, not the ensuing stops triggered.)

We invite well-informed commentary on this subject and would be grateful to any N.Y. traders who know the facts to comment either here on the blog or privately. 

We suppose it is possible that the initial sale was actually much smaller than 124 tonnes, but that it triggered a series of sell stops that collectively amounted to that much, but we are doubtful that the sale which triggered this sell down was “legit” when we look at the facts. 

Our sense is that no one would sell that many gold contracts so fast unless it was with the express intent to drive the market lower and by doing so, trigger sell stops of many other traders - which is, of course, trading for effect, which is patently illegal. (And yes, we know it happens all the time, but there you go.)

Our sense is that we won’t be bothered with any commentary or enforcement action by the CME Group or the CFTC on this issue.  The history of the paper gold and silver futures markets suggests that rules and position limits are just so much sausage – to be ground up by a few elite traders from time to time. 

Not that we are complaining, mind you.  We are merely trying to understand if there really are position limits and whether they should have come into play on April 12, 2013. 

Edit to add:  A trader buddy, responding to our inquiry reminds:  “The hedge members can use their bona fide hedger exemptions to sell more than the limit, but not without filing paperwork with the exchange.”    

If true, and we do believe it is true, then whoever blew out the gold market on April 12 is already known to the CFTC (and what documentation they used to back up their trade).   But don't hold your breath waiting to hear about if from the CFTC under Goldman Sachs-ex Gary Gensler.  

Mr. Gensler is a Goldman sausage grinder from way back... 

Gene Arensberg for Got Gold Report


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Trading gold, silver and mining shares since 1980 with a focus on taking advantage of volatility extremes, Gene Arensberg analyses the markets through a basket of technical and fundamental indicators and shares his findings from time to time here at Got Gold Report. Mr. Arensberg has been quoted in the Wall Street Journal, Dow Jones MarketWatch, USA Today and dozens of other news organizations.

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