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View from the Vault: Something Odd Stirs in Mayfair

By Adrian Ash

SOMETHING odd happened to the gold-investment market in late November. For the first time since mid-July, hedge fund managers stopped betting against the gold price, sparking a one-day jump of 7% on 21st November and the best month-on-month gain in wholesale gold prices for almost 10 years.

Don’t get me wrong; all through this year’s 25% drop, speculative players in the gold futures and options market – that “paper gold” market where traders leverage their money many times over, buying and selling the promise of gold in the future, rather than dealing physical gold today – have remained more bullish than bearish on gold. But last month’s action saw their bull ratio (the number of bullish bets as a percentage of their total position) jump from a 3-year low of 69% to more than 80% inside one week.

Might this signal an end to gold’s steady decline from above $1,000 an ounce? Trouble is, speculation in gold – driven by the New York futures market – still continues to shrink overall. Even as the hedge funds of Mayfair, Connecticut and La Défense reversed course at the end of November, cutting their short positions on gold by one third in just 5 trading sessions, the “open interest” in total still fell by one contract in eight.
That took the outstanding number of Comex gold futures and options to barely one-half of January’s record. Which might strike physical dealers as odd. But the global banking crisis has all but closed new lines of investment credit to speculative traders, such as hedge funds. And that explains why the gold price has fallen so sharply since March, even as retail coin dealers report untold demand for gold bullion products.

Peering ahead into 2009, it’s clear that those hedge funds still standing would rather buy gold than sell it. The end of November saw “large speculators” (as they’re known in the Comex data) add one new bullish bet for every five long contracts already outstanding. Big-name fund managers, including HSBC’s Charlie Morris – head of the $2.6 billion Absolute Return Service – have also started moving back into gold, pointing to the risk of inflation that looms as governments worldwide pump out trillions of dollars in bail-outs and spending.
The problem, however, for get-rich-quick traders trying to get ahead of this trend remains the lack of available credit to fuel short-term positions in futures and options. The real power instead now sits with physical gold buyers. Rather like jewellery consumers, they’d rather buy on the dips, no matter how big. And the last thing they want anywhere near their investment is yet more credit and leverage, the precise cause of today’s bust in hedge fund and speculative finance