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Following on from last week, why do I say that the nature of the gold
market itself makes profitable day trading difficult? It is all about
information, or lack thereof. Apart from pockets of relative transparency
like COMEX or ETFs, the vast majority of the market is opaque. The
“retail” or “average Joe” trader simply does not have
access to the same amount of information about the status of the market and
its flows that a “wholesale” trader does (and even they can’t
see the entire market). Without understanding what is really driving short
term changes in the price, I doubt it is possible even for the most astute
and disciplined trader to make consistent profits.
Let me contrast it to stock markets. There are a few key features that help
the day trader. Firstly, you know exactly how many shares have been issued
and if there are different classes, how many of each and what the
differences/rights each has. Secondly, all trading is done through (usually)
one regulated market. Thirdly, you can see daily trading volumes. Fourth, at
any point in time you can see the depth of the market – how many shares
are being offered to buy or sell at each price level. This mass of data,
combined with analysis of price charts, gives the trader room to apply skill
and a bit of gut instinct to the task of making a profit.
How does the gold market stack up on these features? Firstly, no one knows
for sure at any point in time how much gold there is out there to be traded,
nor in what form or in what locations. The wholesale market may have a bit of
an idea, but no such information is published to retail traders on a daily
basis. Even if one did know the size of the gold out there at that point in
time, due to its refinability, scrap gold can flow
back into the market quickly (a factor if you are planning on holding a
position for a few weeks), so the total “shares on issue” in not
fixed and changes in response to the price.
On the third and fourth points, there is no published information on daily
trading volumes or market depth; indeed, no volume data is published at all.
I’m talking here about the whole market. Sure, some gold is traded on
regulated markets but that information is only part of the picture and
certainly little of it is live. If you only have part of the story, you
don’t have the story at all in my opinion.
Network Nature of the
Market
The key killer for me is the second point – gold is simply not a
publicly, regulated traded thing. And COMEX and ETFs and the like don’t
go anyway towards solving that because they are not closed systems. It is
easy to run a position in those markets that are offset or hedged with an
opposite position in the spot/forward market. Detailing how that is done is
for another blog. The gold market operates much like the internet – it
is a network of wholesale dealers, independently trading with each other, and
it is the sum of those individual trades that makes up the “spot
market”.
It was always amusing to me when clients would ring up to buy and we would
quote a price and then, naturally, they would say “Well, where can I
get what the spot price is?” so they could work out if our price was
“fair”. The answer was, “It doesn’t exist. You could
spend a few thousand getting a live Reuters data feed, but even that is just
indicative.” Being used to the comforts of a stock market, many
didn’t like that answer and thought we were pulling a shifty on them.
In the end, all we could say was that they had to do what we did, which was
ring around to see who was offering the best price at that time. It made some
uncomfortable, but as I pointed out in my first blog, this is the
“pointy end” of investing, it’s real trading, it is about
bargaining, haggling, being in the know.
The funny thing is that this network nature also gives the market strength.
Transparency is nice, but not at the expense of robustness. Just like the
internet, where if a part goes down then data can be rerouted, if London was
nuked for example, then trading in gold could still continue. Sure, liquidity
would be reduced, but as deals in the end are done over the phone, it is just
a case of dealing with other counterparties in other countries. Because it is
not locked in to one “exchange”, gold can be resilient in the
face of a failure in part of the network. And this is how the medium and long
term investors want gold to trade if it is to be the asset of last resort.
The market needs that flexibility to if it is to continue trading.
But the network nature of the market and the corresponding lack of
transparency is a problem for the day trader. To understand what the retail
trader is up against, it may be better to explain what happens when they call
up to buy some gold from a dealer. There are many small variations to how
this can work; this is but one way, probably the simplest where a dealer just
lays off a trade with someone else immediately instead of holding a position.
Spot Trading
Any trading desk needs an indicator of where the market is, and most use
Reuters. However the price displayed on Reuters under code XAU is just an indicator.
It is updated by the bullion desks of the big banks and is in effect, a
bulletin board or forum where banks can publish their prices in the hope
other dealers will call them up to do a trade. Sort of like an advertisement.
Unlike a stock market, it is not a commitment to deal at those prices, but
most times you can. However there are many times, especially when the market
is moving quickly, when the dealers don’t have time to update their
quotes on Reuters and so when you ring them up,
they say “Sorry, Reuters off the market, my current price is $5 below
the screen”.
As a result, when you call a dealer for a price, they themselves cannot
really know exactly where the market is. They see $900 on the Reuters screen,
but this is what they will be charged, so they have to add something on to it
as they have to make a profit (you expect something for nothing, it costs to
run a trading desk, to talk to you, to do the other side of the trade with
the bank, to settle the funds, bank fees etc). The dealer also has to
consider that by the time they get off the phone with you and then call
another wholesale dealer the market may have moved, so they might need to add
a buffer on top of their margin. Sometimes if your deal is big enough and the
market volatile, they’ll get another trader on their desk to call a
bank and get a firm price before they quote to you (and they’ll want an
answer quick because the bank ain’t gonna want to sit on his quote for too long because
he/she has got to trade it as well).
Dealers have a network of other dealers they trade with. Each dealer has a
different bit of the gold market pie, they can see what is driving their
deals (be they a refiner selling a miner’s gold, a bullion dealer
selling coins and so on), but not necessarily what is driving other flows.
They are in constant contact with each other, doing deals, talking and
exchanging information on what they are seeing in the market, watching the
Reuter’s price movements. They use all this information to set their
prices and to ensure they don’t lose money. Over time they build up a
gut instinct, a feel for market movements and where it might go that day.
If you call up the Perth Mint to trade, you are likely to speak to Deniece, the Mint's senior bullion dealer. She has what I
would consider probably the best background training for a bullion dealer -
croupier at Sun City. When the market is moving you can do any number of
deals before you have time to enter them into the system to confirm your
position and profit, so you have to be able to run them in your head, to know
where all your 'gold chips' are on the 'table'. She has been there since 1994
and every working day she has been sitting in front of a computer screen
watching the Reuter’s gold price tick up and tick down, talking to
people like you wanting to buy or sell gold – that’s coming up to
4,000 days of trading. And you think you can day trade against dealers like
her, with zero information about what’s going on in the market? Get
real.
Bron Suchecki
Goldchat.blogspot.com
Bron Suchecki has worked in the precious metals
markets since 1994, when he joined the Perth Mint as an Administration
Officer in their Sydney retail outlet. In 1998 he moved to Perth to work in
the then fledgling Depository division. He has held a number of roles since then
in the treasury, risk and governance areas of the Mint.
All posts are Bron's personal opinion and not
endorsed by the Perth Mint in any way.
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