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Gold Prices Ripe for ‘Mega Short Squeeze,’ Fund Manager Says

January 19, 2016, 3:45 P.M. ET
By Chris Dieterich
Barrons

Link: http://blogs.barrons.com/focusonfunds/2016/01/19/gold-prices-ripe-for-mega-short-squeeze-fund-manager-says/

Defensive buying has launched gold prices and exchange-traded funds to a strong starts in 2016. Have the fund sellers finally had enough?

Gold futures and the SPDR Gold Shares (GLD) are both up by about 2.5% so far this year (though both are slightly lower in Monday trading). Money is starting to flow back into gold ETFs, however incrementally. Nikolaos Panigirtzoglou at J.P. Morgan notes that gold ETFs took in about $900,000 during the week ended Jan. 13, the most recent week available. For the sake of comparison: Some $3.6 billion was pulled from gold ETFs last year, representing about 7.4% of total assets under management..

John Hathaway, manager of the $842 million Tocqueville Gold Fund (TGLDX), which owns precious metal stocks, says that gold bears could wind up with egg on their faces should the years-long trend of pulling money out reverse in earnest. He explains (or read the whole 7,000-word treatise here):

“The seemingly endless supply of notional gold coming from the sellers of synthetic is the strongest explanation for the extended, and in our view overdone, decline in the gold price from peak levels of 2011.

Quantities of synthetic gold sold are created out of thin air, with almost no connection to physical metal. The negative investment thesis seems to rest upon confidence that central bankers, and the Fed in particular, will steer a course away from radical monetary experimentation that will return to a normal structure of interest rates and robust economic growth.

The fact that these expectations have not been fulfilled in the nearly nine years since the initiation of zero interest rates, notwithstanding the recent 25-basis-point Fed rate hike, leads us to believe that investor credulity in central bankers may be stretched about as far as it can go.

The very popular short exposure in gold is, in our opinion, vulnerable to a trend reversal/mega short squeeze. This would occur if gold ETF assets under management (AUMs) were to rebuild or if holders of COMEX futures were to stand for delivery in a big way.

Gold ETF AUMs peaked at 2400 metric tons (“t”) in December 2012 vs. 1300 currently. A 200- or 300-t influx to GLD and other ETFs would put a severe strain on London liquidity, which we estimate to be substantially below 1000 t currently.

When and why a trend reversal might occur is a matter of guesswork, but a trend change is inevitable (as in all markets), and the dynamics promise to be powerful. In our view, the short interest in paper gold rests on a credit pyramid that is precarious. When a trend reversal occurs, we expect that machine-driven trading, which is agnostic as to investment fundamentals, will serve as a powerful accelerant to the upside, just as it has led to overshooting on the downside.”

While gold prices have been firm so far in 2016, the same cannot be said for shares of gold miners. These have been hit hard this year, in line with other commodity producers. The Market Vectors Gold Miners ETF (GDX) and the Market Vectors Junior Gold Miners (GDXJ) have been hit for 9.3% and 11%, respectively. Both are on pace to finish at record lows on Monday. That’s worse than the 8.2% drop in the SPDR S&P 500 (SPY). Hathaway is nonetheless optimistic for a turnaround:

“There are numerous catalysts to trigger a change in direction for gold. These include, but are not limited to, a bear market in financial assets, a downturn in the global economy, continued currency turmoil, and of course, bullish supply-and-demand fundamentals. To this list, one must add geopolitical issues; the headlines speak for themselves. We expect these catalysts to interact and feed on each other. …


Since 2009, strong financial-asset returns and confidence in central banking have become intertwined, in our opinion. Many investors with whom we have met over the past two years with seem to understand the potential downside from reliance on this fragile game of confidence. However, to initiate a position in gold or gold mining stocks is seen as potentially career-threatening at this juncture in part because the confidence game has persisted for so long and in part because adoption of precious-metals exposure is seen as potentially harmful to performance. We therefore believe that the latent demand for the risk protection that gold can provide is vast, and that it will be activated in a reflexive, convulsive fashion when confidence in central banking evaporates. …

Ownership of physical gold outside of the financial system seems to make more sense than ever. Gold-mining equities, which have been severely depressed by the four-year decline in the gold price, should also participate. We believe that a trend reversal could prove explosive for the entire precious metals complex.”