Monday, April 15, 2013

A Bit of the Old Ground and Pound

What is happening to gold right now foretells the future for stocks. For years - since the bottom in 2009 - apologists for the status quo have been saying that low volume is not an issue, merely because it hasn't been so far. However, volume equals liquidity and lack of liquidity is a big reason why gold can't find a bottom...

The Elbows are Raining Down on Gold
The massive two day 10% decline in gold can go a lot further before it ends. Gold is not a highly liquid investment, which just means that it trades at relatively low volumes, so a fund that has a large position has to take its time getting in and out of gold, or it can move the price. As we see, in roughly two days, gold is now down substantially with no sign of bottoming. Gold has been in a bull market since 2001, which means that big money funds took their positions over a course of years, taking advantage of pullbacks to add to their positions. During the ascent, gold's relatively low volumes were not deemed an issue; now however, during the decline, that low volume translates into buyers that are few and far between, faced off against highly motivated sellers. Add in the fact that gold essentially trades 24 hours a day during the work week across three major time zones - U.S., Europe, Asia and "limit down" (trading curbs) in one time zone, merely equate to the opening price in the next time zone. A lot of damage can be done that way in 24 hours, especially in the futures pits where gold can be max leveraged ~17:1 - i.e. a 6% move in gold wipes out all equity. As I write, the GLD (Gold ETF) has traded a day's worth of volume in the first half an hour...

The Elbows Will Come Out on Stocks Too...
Of course the same arguments have been made about stocks since 2009. Low volume was not deemed an issue. It was all a big phony rationalization to overlook risks while buying stocks, of course. Big funds built up their stock exposure over four years, taking advantage of the various pullbacks - the Flash Crash (2010), the Debt Downgrade meltdown (2011) etc. Now however, stocks are at nose bleed levels and institutions are already picking up their pace of selling as indicated by the number of "distribution days" - high volume down days interspersed with low volume up days. Meanwhile, as I have shown many times, overall stock volumes have been falling steadily for years, and an ever-increasing amount of those low volumes is accounted for by HFT-bots scalping on millisecond boundaries - it's meaningless churn that adds to the volume count without creating true liquidity. The question on the table then is much of that dwindled volume equates to real buyers willing to hold onto stocks for more than :15 minutes? So now we have a situation in which major institutions are trying to move massive amounts of stock while the HFT bots that make the market, try to keep their positions as small as possible. During the 2010 Flash Crash, the market was not stabilized by the "fast money", it was stabilized by large institutions that had capital available and stepped in to take advantage of low prices. Now imagine the same scenario, except large institutions are not in buy mode, they are in sell mode, because they are already "all in". Meanwhile, the issues with the HFT bots that initiated the Flash Crash in 2010 were never resolved i.e. the situation by which the bots went from being liquidity makers to being liquidity takers. They sold into the decline rather than trying to reverse it. Alas, none of those issues have been addressed in the interim. So, those who said that low volume is not an issue, will come to realize that volume is liquidity and when liquidity is low, prices can move very quickly indeed.

In The Idiocracy Nothing Matters Until It Matters
Therefore, this will all culminate in what I call "discontinuous price discovery"...

Risk Off
The other, totally overlooked connection between gold and stocks, is that they are both correlated to the "risk on" trade. Last week we saw the Russell 2000 make a hard reversal against a new high, and then rebound to a lower high creating a right shoulder. The R2K represents the leading (until last week) and most speculative stocks - which are now underperforming the market. Meanwhile, Bitcoin which has been the poster child indicator for the current manic bubble, of course, wiped out in a mere three days. Now gold's turn. Risk appetite is waning and in this binary world created by Central Banks, that means everything risk related will get sold hard.

GLD (Gold ETF) exhibiting discontinuous price discovery - now in "No Man's Land".