ROSS NORMAN : Gold and The Art of War
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Unusually, gold is not itself these days.
I say “unusually” because the gold price could - in normal times - be relied upon to give a measured view on the state of the world - both economic and geopolitical cycles ; so, over and above its own supply/demand fundamentals, it is regarded as a scorecard of sorts.
Given that the gold price reacts to a very wide selection of economic indicators has prompted the comment that it represents “the sum of all fears”. As a gauge, it shoulders quite a lot of responsibility. Sometimes a little dull, but often reliable.
… so it matters and hence it is widely watched.
Trouble is ...since 1st March 2024, gold seems to have dissociated itself from most of its traditional relationships, leaving the door wide open for interpretation … I will come back to this point at the end of this note.
Now, if winning matters to you … no matter what the field … then the military treatise “The Art of War” written by Sun Tzu in about 300 BC is essential reading. The guidance applies to military combat, to business negotiations and to regular, everyday life issues. And within the context of the current gold market, there are lessons to be drawn from the book and helpfully, both are linked to China...
The Art of War – if I may paraphrase - is essentially about how to win a war without a shot being fired, but if you must come to blows, then it gives clear rules which if applied will ensure victory. Sun Tzu was undefeated in battle.
Central to this philosophy is to prepare thoroughly … then attack, clear of any doubt and with total conviction ; such seems to be trading strategy of the Chinese derivative traders currently leading the gold price, in my view … full on, and unremitting.
“Let your plans be dark and impenetrable as night, and when you move, fall like a thunderbolt.”
The leading players behind the gold price rally certainly came out of left field for Western observers. Zhongcai Futures who hold very significant positions in both gold and silver was spun out from its parent company who are PVC pipe manufacturers.
What makes the move by Zhongcai Futures interesting is not just the size of their position - but their method too – that is to say using both highly leveraged futures and options – operating across various jurisdictions in both their domestic market on SHFE as well as the CME in New York ; futures contracts are typically cash settled or simply rolled but it appears many of the Chinese dealers are “standing for delivery” as their futures contracts expire – draining metal out of the system. It's all very different.
Back in the day … in the 1980's and 1990's that is, such shenanigans were commonplace in the West with a number of predatory players prepared to take a large but calculated bet if they felt the market was mis-priced. Today, like our culture, we are softer and more cautious.
Zhongcai's majority shareholder, Mr Bian Ximing (Zhongcai Futures has a reported capital base of just $41m) has according to a story on Calliain News Agency (see here) amased a position of about 58 tonnes of gold futures in April 2024 plus a sizeable gold options position too. These are just the trades reported by the exchanges, but likely as not they and other Chinese speculators may be holding additional positions secured via trades in the OTC market.
It was also reported in the Chinese media that Zhongcai Futures had made around 5.44 billion yuan from gold trading futures in H1 2024 - which is over $753m. Nice.
Note - it is not clear whether these profits are simply mark-to-market gains or profits actually taken.
But Zhongcai are not alone. Haitong Futures, Yongan Futures and Guotai Junan Futures have also placed big bets on gold and silver according to Cailian News Agency with the first two having made $166m and $124m respectively in the first 6 months of this year.
Arguably many of these positions were conceived and entered during Q1 2024. Back then the PBoC gold buying was hot, institutional gold purchases by Chinese institutions via their ETF was firm, retail gold demand was going gang-busters, drawdowns from the Shanghai Gold Exchange was epic (often seen as a proxy for local offtake) and was a massive 500 tonnes in Q1 and loco Shanghai prices were running at a fat $45 premium (about 2%) over the international price. One might add that meanwhile the Chinese equity market, the Shanghai Composite was under serious pressure and the real estate crisis was deepening. So these positions were entered at a particularly auspicious time. Thing is … things have changed.
The PBoC have stopped acquiring gold, jewellery demand has cratered, and loco Shanghai premiums have disappeared – reflecting poor demand - and gold is now trading in Shanghai at a small discount, reflecting a major reversal.
A chum suggested discrete Central Bank buying behind the scenes may account for the price move – I would doubt it – it is almost impossible to entirely cover your footprints without it being apparent in one of about a dozen indicators.
Meanwhile gold's expected inverse correlation with the US dollar and US treasuries are all completely out of whack at +0.42 and +0.35 respectively YTD and it seems impervious to geopolitical issues (gold was unmoved when a sniper winged Trump) while ignoring the higher for longer rates narrative. Meanwhile physical demand in the West is catastrophically poor (forgive the hyperbole). In theory, gold should be very significantly lower.
In short, gold continues to bounce around on delta hedging on those leveraged trades, playing out in a low participation rally. To date the Chinese speculators have won the battle – but not the war … yet. If the world recalibrates its view on things economic and political we may see demand kicking in again at these elevated levels eventually... if not, gravity will take hold when those options expire and we settle at a lower level – it is just not yet clear which side will win out just yet.
If the parallel with the book the Art of War holds true, then you should expect “flexibility and subtlety” in terms of how things play out for gold – likely as not, this is to say you probably will not know the Chinese traders have exited the field until well after the event, leaving us all wondering what the hell just happened.
Ross Norman
CEO
Metals Daily Ltd, London