Judgement Day is Coming: How High Frequency Trading Affects Commodities11 min read

Judgement Day is Coming

Eventually, the market will tell the tale.

I urge all my readers to listen carefully to what I am about to say – to read between the lines and listen to the facts presented. From there, feel free to make your own judgement.

Since the crash of 2008, high-frequency traders have caused U.S. commodity futures prices to disconnect from market fundamentals of supply and demand.

While those involved in high frequency trading (HFT) claim that it brings more liquidity and price discovery, it hasn’t. As a matter of fact, it’s forced retail investors out of the picture due to the volatility it has created.

The United Nations Conference on Trade and Development just published a report that HFT’s impact on commodity prices have clearly taken away from the fundamentals of supply and demand:

“(The) recent price movements of commodities are hardly justified on the basis of changes of their own supply and demand. In fact, the strong correlations between different commodities and the S&P 500 at very high frequency are really unlikely to reflect economic fundamentals since these indicators do not vary at such speed.”

Practically everything in our world has been turned into a financial instrument.

As I mentioned in ‘More Stunning Results,” if you delve deeper into the way the world’s financial system works, you will see that the amount of leverage through derivatives and paper trading are at astronomical levels. You will see that more value of this trading exists than the world’s overall GDP combined – by more than 10 times.

Leverage and HFT’s have given path to a new wave of manipulation, making price discovery via supply and demand fundamentals next to impossible in the short term.

Over the last year, and in particular the last few weeks, the blatant price manipulation of both gold and silver have been extremely obvious.

When Silver is Faster than Light

I just mentioned how derivatives and financial instruments are influencing real market fundamentals. The guys over at Nanex Research just showed us how unbelievable manipulative trading can be:

“On March 20, 2012 at 13:22:33, the quote rate in the ETF symbol SLV sustained a rate exceeding 75,000/sec (75/ms) for 25 milliseconds. Nasdaq quotes lagged other exchanges by about 50 milliseconds. Nasdaq quotes lagged other exchanges by about 50 milliseconds. Nasdaq quotes even lagged their own trades — a condition we have jokingly referred to as fantaseconds.”

A millisecond is equal to 1/1000 of a second.

What does that mean?

The flaws present in today’s trading systems can easily be leveraged to manipulate prices. In the SLV case (a silver-backed ETF that tracks the price of silver), it means that some traders flooded the system with sell orders which, due to the security holes that exist, caused silver prices to drop considerably.

These high frequency traders clearly took advantage of the flaws and exploited the SLV by making trades that, when computed, exceeded the speed of light and thus throwing out real time market fundamentals out the door.

The fantaseconds Nanex refers to is a term that defines a unit of time measurement which was unveiled back in September 2011 when a “time warp” was recorded in the trading of Yahoo! stock.

At the time, exchange timestamps revealed that the Yahoo! trades were executed on quotes that came into existence only 190 milliseconds later – meaning the trades technically occurred in the future.

By taking advantage of this flaw traders can execute quotes before they even exist in the system. That means these traders can set their own prices by bypassing other current market orders.

Because the silver market is small, it doesn’t take much to manipulate its price. But what about the much larger gold market?

A Gold Manipulation Example

On February 29 in the Asian market, gold was closing in on US$1,800, up more than 15% from December. Silver rose just below $$37.50 – up more than 40% from its December lows.

Technical charts and analysis clearly showed that both gold and silver were pushing past major resistance point and looking to climb much higher. I explained this in a previous letter. Even the mainstream financial media were beginning to take notice that investors both large and small were acquiring precious metals.

That same day, the European Central Bank (ECB) gave 800 banks €529.5 billion ($710 billion) of new loans at 1% for three years using almost any form of collateral (see What You Don’t See Behind the Scenes). Again, I stress that this is just another form of Quantitative Easing, which would generally send gold and silver prices much higher. It did…but only briefly until N. American market trading began.

News of this round of quantitative easing was the last bit of news that was driving up gold and silver prices prior to 10 AM Eastern time in the US.

Right at 10am, an order to sell around 1 million ounces of gold came in (worth about US$1.8 billion dollars.) Minutes later the same seller sold another 800k ounces. That one seller sold 1.8 million ounces of gold (worth about US$3.24 billion) within minutes.

At the same time, around 225 million ounces of silver were sold on paper contracts – that’s more than 20% of the global silver supply – all happening within minutes.

When selling anything, the objective is to get the highest price possible – especially when you are selling nearly 2 million ounces of gold worth well over 3 billion dollars.

Someone who is looking to sell a position of a million ounces of gold at the highest possible price would spread the trade out over time and among different brokers. Someone selling an entire lot in a single transaction is obviously looking to knock down the price of gold rather than engage in a genuine market transaction. In other words, that type of selling is generally associated with manipulation.

(Manipulation – although illegal – happens all the time. They are often collaborated efforts by hedge funds, institutions, or retail investors with tons of cash. But manipulation is also hard to prove – there are day traders, algorithms, and so many factors that could influence trading activity.)

So why would someone sell more than US$3 billion worth of gold like that? Did this person truly believe gold would drop? Or was this person looking to force the price of gold down? More importantly, who is behind this and why are they doing it?

You Be the Judge

The price of gold has climbed dramatically right alongside the rapid rise in debt the US has incurred. That means the price of gold is an effective report card on the value of the US dollar, the US government, and the US economy.

Manipulation aside, the prices of gold and silver tend to rise as the US dollar falls or the US government or economy grows weaker. This relationship creates a huge incentive for the US government to suppress gold and silver prices.

Bernanke has downplayed gold (click to see video) as a form of money many times before. He doesn’t like seeing gold go higher. He wants people to buy treasuries – not gold.

So what’s the best way to suppress gold and silver prices? Make people afraid to own it.

Volatility has already wreaked havoc on investor sentiment given the events of 2008. Stock market volumes remain extremely low and investors continue to look toward risk free returns – even if those returns are losing money when adjusted for inflation. What better way to have investors exit a market, or shy away from one, then by making a market even more volatile? Given 2008, it doesn’t take much nowadays to scare off investors.

So whose hammering gold? You be the judge.

Pan Asian Gold Exchange Gets Axed

On February 29, the same day both gold and silver were crushed, it was announced that thePan Asian Gold Exchange (PAGE) had effectively been killed before it could go into operation.

Apparently, a part-owner of US origin and possibly affiliated with a large US bank had managed to get 24% of the voting control of PAGE, then appointed enough members to the board of directors to succeed in postponing the commencement of operations. At least one of these elected board members was alleged to be a former member of the US Federal Trade Commission.

If you remember from a letter a few weeks back, PAGE would have given 320 million retail customers and 2.7 million corporate clients in China the ability to buy gold in 10 ounce increments with the click of a button – with all contracts 100% backed by physical gold. This would’ve given complete asset protection for investors – much more protection than those overly leveraged paper contracts that are traded on the COMEX and London markets.

That means gold would’ve climbed dramatically as physical demand seriously outweighs supply.
The US and the exchanges that currently control most of the gold and silver paper contracts would not have liked this.

But it’s not over.

According to reports, other part-owners of PAGE have announced that they are reorganizing and looking to begin operations of a new exchange operating the same way as planned for PAGE.

China is already the biggest holder of foreign reserves and gold. They will continue to encourage their citizens to own gold because eventually, gold-backed currency could reign supreme.

The world already knows they are losing their purchasing power because of the amount of liquidity the Fed and the ECB have let loose.

Countries and central banks around the world are continue to hoard gold (see The Hoarding Has Begun).

And it’s just the beginning.

Countries Continue to Hoard Gold

The Turkish government, facing a bloated current-account deficit that threatens to derail the country’s rapid expansion, is now trying to persuade their citizens to transfer their personal holdings of gold into the country’s banking system.

According to WSJ:

“Government officials say the banking regulator will soon publish a plan to boost incentives for consumers to park household wealth inside the financial system. Banking executives said they are considering new interest-yielding gold deposit accounts that would allow savers to withdraw gold bars from specially designed automated teller machines.

The moves come after the central bank in November announced that lenders could hold up to 10% of their local currency reserves in gold, in part to tempt Turkey’s gold-hoarders to deposit jewelry, coins or bullion at banks.

Economists say the policy shift is designed to change Turks’ historic preference to store a high percentage of personal wealth outside the banking system to decrease exposure to currency volatility or financial crises, which have periodically hit Turkey’s economy in recent decades. The effort also forms one front in a broader battle to lift Turkey’s low savings in order to curb the fast-growing economy’s ballooning current-account deficit–a pressure point many investors fear could upend an economy expected to have grown more than 8% last year.”

Click Here to See the Video

The End Game

Interest rates have been falling for over thirty years. The Fed is no longer in control. Speculators are the only ones left buying US bonds. And they’ll keep buying them as long as they can profit in risk free paper. But when the Fed floods the market with QE and bypasses the open market (illegally) by buying bonds directly from the Treasury, it forces many of the bond traders out.

There is a reason why we have just recently experienced a heavy selloff in the bond market. Soon, there will be shorts and the money will be transitioned over to the commodities market – a market that will rise as more money is printed to buy the bonds that investors don’t want.

For now, we must be patient. We must understand that resource stocks may fall with the market. But in the end, when commodity prices are the only thing that is rising – the stocks associated with it will too.

Judgement day will come.

Until next week,

Ivan Lo

Equedia Weekly

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Disclosure: I am long gold and silver through ETF’s and bullion, as well as long both major and junior gold and silver companies.

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