Negative GOFO and Rising Gold Prices
Have you ever had one of those thoughts tumbling around in your head for days? Usually, it lingers there until you finally try to put the pieces together. This happened to me yesterday and the result is something that needs to be widely shared, thus this public thread.
As most are aware, the LBMA publishes Gold Forward Offered Rates (GOFO) every day. You can find all daily updates and 25 years of GOFO history by clicking this link: http://www.lbma.org.uk/pages/?page_id=55&title=gold_forwards
Our friend, Denver Dave, published a concise, easy-to-understand explanation of GOFO back in July. I encourage you to read it before you go further but, in summary, it goes something like this:
Positive GOFO is the historical norm. Negative GOFO, when it appears, means that physical gold is preferable to dollars and, thus, indicative of a shortage or supply squeeze.
I would take this this one step further. In the 45 years since the collapse of The London Gold Pool, Central Banks have stood ready to lease gold to the Bullion Banks. The Bullion Banks, in turn, take this leased gold, leverage it through paper derivatives and dump it onto the futures markets in order to suppress and manage price. The Central Bank willingness to lease their gold was apparent through the persistently positive GOFO rates. In fact, from 1989 to mid-2013, GOFO rates were negative for just seven days.
September 29 and 30, 1999
March 9 and March 12, 2001
November 20, 21 and 24, 2008
That's it! Seven days out of about 5,000 or 0.14% of the time.
However, I think we can all agree that things have been fundamentally changing in the gold market. Against most expectations, price collapsed from $1800 to $1180 between 10/1/12 and 6/28/13. This manufactured price drop only served to exacerbate the extreme levels of demand that have been seen since 2010, particularly from China. So it came as no surprise that on July 8, 2013, just five market days after The Price Bottom was reached, GOFO rates turned negative. This time, however, rates did not flip back to positive after two or three days. Instead, rates stayed negative for 40 days.
Yep, you read that right. After only being negative for 7 of the previous 5,000 days, GOFO went negative for 40, consecutive market days from July 8, 2013 to September 2, 2013. And what happened to price during that time?
On Friday, July 5, price closed at $1213 and GOFO went negative in the morning of Monday, July 8. After rallying through July and August, price peaked on Wednesday, August 28 at $1433. That's a move of $220 or 18%. Not coincidentally, GOFO rates "bottomed" on August 22 and flipped back to positive on September 2. Price began to move sharply lower and, by September 18, had fallen as low as $1308. Though there was a brief period of flat rates in mid-September, GOFO rates remained positive until October 16, 2013.
In the time since, GOFO rates have vacillated between positive and negative, roughly coinciding with Comex delivery months. In short, if The Comex is in a delivery month like October, December or February, GOFO is likely to be negative. If it's not a delivery month, like September, November or January, GOFO will likely flip back to positive. It looks like this:
July 8, 2013 - GOFO moves negative
September 2, 2103 - GOFO moves back to positive
October 16, 2013 - GOFO negative
November 6, 2013 - GOFO positive
December 9, 2013 - GOFO negative
December 12, 2013 - GOFO positive
December 18, 2013 - GOFO negative
January 16, 2014 - GOFO positive
February 4, 2014 - GOFO negative
March 3, 2014 - I expect GOFO to be positive again on Monday. See the recent trend below:
21-Feb-14 -0.05400 -0.03600 -0.01000 0.03400 0.11200
24-Feb-14 -0.05000 -0.03400 -0.01200 0.03200 0.11200
25-Feb-14 -0.04600 -0.03000 -0.01200 0.03400 0.11400
26-Feb-14 -0.03800 -0.02400 -0.00600 0.03200 0.11400
27-Feb-14 -0.02400 -0.01400 0.00200 0.03400 0.11600
28-Feb-14 -0.01400 0.00000 0.01600 0.04800 0.12400
Let's cut to the chase. Here's what I think...
The days of Central Bank gold leasing are almost over. Whether the CBs are "out" of gold or simply unwilling to lease what they have left for fear of not getting it back (from China), the CBs are not playing the gold leasing game like they have for the past 45 years. Again, for the past 24 years, GOFO rates were negative just 7 out of 5,000 days. Since July 8, 2013, GOFO rates have been negative for 98 out of 164 days or roughly 60% of the time.
Put another way, positive GOFO means "business as usual". Central Banks are willing to lease gold to the Bullion Banks. The BBs take this gold and dump it onto the futures market, using this scheme to contain, manage and suppress price. This worked perfectly until 2003 when demand and fundamentals overwhelmed this scheme for the next nine years and price rallied from $300 to $1900. Leased gold was continually dumped from October 2012 until late June 2013 and the resulting decline took gold back from $1800 to less than $1200.
But, now, negative GOFO is the new norm. Why? Because the CBs no longer have the gold to lease to the BBs. Without this readily available physical supply, the BBs are unable to aggressively manage price on a day-to-day basis and they are forced to stand down. Instead of daily 7:00 am London time price raids, we only get one per week. Instead of "waterfall" declines on the Comex, we get gradual and steady price increases.
All of this would just be theory if there wasn't price data to back it up and this is the point where the pieces began to fall into place for me yesterday. Please take a moment to ponder the chart below. It shows the last 12 months of daily price action. All of the price change on the left side of the chart, up to the first red arrow, occurs in a period of consistently positive GOFO. Look at the price action since July 8, when GOFO first flipped negative and then look at all the other arrows. Red arrows point to dates where GOFO flipped negative. Black arrows point to dates where GOFO flipped back to positive. (click the chart to expand)
Do you see a trend here? Isn't it quite clear that when GOFO is negative, prices generally rise and when GOFO is positive, prices generally fall? Here, let me make it easier for you...Longtime Turdite "Pining" added some color and number to the chart. Now take a look. What do you see?
And here is where I think we are onto something. Let me explain...no, there is too much...let me sum up:
- Extraordinary global demand (China, German gold repatriation, etc) has made the supply of readily-available and deliverable gold extremely tight.
- Central Banks are no longer willing to lease gold into the market every single day OR
- The CBs do still lease every day BUT, during Comex delivery months, the extra physical demand is just enough to tip the scales out of balance and drive GOFO negative.
- Negative GOFO indicates a shortage of London Good Delivery Bars for leasing and delivery.
- A shortage of bars precludes the BBs from heavily shorting and driving price lower.
This leaves us with this conclusion for traders and stackers everywhere:
Buy when GOFO is negative. Be cautious, sell or hold off on new purchases, when GOFO is positive.
Could it be as simple as that? Yes! It may very well be, at least for now. Rest assured, I'll be following this trend very closely in the weeks and months ahead. Be sure to join us in The Vault every day for complete coverage, analysis and updates.