An Inside Look At The Shocking Role Of Gold In The “New Normal”…( Must Read For All Investors!!)

Saturday, December 6, 2014
By Paul Martin

Paul Mylchreest of ADM Investor Service International

Long Nikkei/Short Gold: Profitable, dangerous and missed by everybody?

Has the market completely missed a huge long/short trade which has helped to drive up the Nikkei and drive down the gold price for more than 2 years? One that puts risk-taking and leveraged speculation by our industry in an unfavourable light again.

Executive Summary

In the report we outline a thesis which draws together a complex web of interactions between Japanese equities, the gold market, repo financing, BoJ monetary policy meetings and anomalies in the silver market.

These interactions began forming in late-2012, specifically around September, as far as we can tell. With hind-sight, this was a pivotal period in recent financial history, when central banks embarked on a new phase of aggressive credit creation. We found no evidence of these interactions beforehand and think it is fairly unlikely that they are merely the result of coincidence.

At the centre of this, it looks to us like a large, leveraged long/short trade has been built up which is long the Nikkei index and short gold. The more the Nikkei has risen, the more the gold price has been pushed down.

It’s a clever trade from a cynical perspective, as we’ll explain. However, it also raises concerns regarding risk taking and the measurement of risk which have made speculative abuses by some entities in our industry (especially banks) only too infamous in recent years.

If we are correct about this trade, a shock affecting either the long or short side could roil financial markets if it was unwound in a disorderly fashion. Potential threats include:

Growing criticism of Abenomics and weak economic performance in Japan;
Increasing signs of schism in gold and silver markets between strong physical demand and price discovery which is dominated by paper instruments and which has almost reached nonsensical levels; and
Interest rates in the repo market have started to rise with the Fed winding down QE3.

Going into a bit more detail…

We suspected that gold might be the short in a long/short trade when we noticed a reasonably close correlation between gold and interest rates in the repo market. The more the cost of repo funding declined, the more the price of gold declined.

The Rest…HERE

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