Keeping it Simple – Soren K. Group
We Can’t Know
The title implies we can know without a doubt why Gold is dead since 2011. The reasons for Gold’s demise cannot be known through deductive methods. To do that we need facts. To get facts we need Government transparency. That isn’t happening.
So we are left again with subjective probability which is inductive in nature and leads one to seek facts to confirm a thesis for deductive “definitive” conclusions. But again, that ain’t happening. So we have the “Walks like a Duck” tool.
And this situation does not get more duck-like unless it came and bit us on the ass.
But We do Know
For us, it is without a doubt manipulated. For the legally minded academics and a court system that needs pictures of the fire’s flames to declare it as such, feel free to choke on the smoke while waiting for the polaroid. We are out of here. The game is rigged
To understand why Gold has been under water after 2012, one must step off Gold island and look at the whole market place. The point is simple. It is being manipulated, but not in the way you think. It is worse
Since 2012 Gold is just a side show in what is clearly become a plethora of broken markets based on how risk is priced.- VBL
Gold is One of Many
If one looks at a measure of risk / reward that is used by hedge funds, one sees a breaking market starting in 2012. The measure is based on the high historical positive correlation between the S&P Vix and an indicator called the Economic Uncertainty Index. Before 2011 these 2 moved in tandem which makes sense. First here are the basics
- Vix – commonly reasoned that the higher the Vix, the higher the market’s perception of risk as more people are buying options (puts)to hedge their positions. – We have a lot of problems with this but that is for another time
- ECU- the higher it is, the more uncertainty it reflects
In 2012, these 2 indicators which had run closely began to diverge. In the professional trading community it had been a joke since 2008 that the Plunge Protection team (PPT) – which actually is a thing – that had been buyers of stock during past crises had instead started to sell puts (or the Vix itself) on the S&P to keep implied Volatility down. Now, how does that keep stocks up? Speaking as a professional trader, here is the answer key on how manipulating the Vix keeps stock prices higher.. and ultimately Gold lower.
Manipulating the Vix
If you are the US government and you incessantly sell puts on stocks in the market, you move the price of puts lower. This makes them less expensive for portfolio managers to buy. A portfolio manager who buys puts as insurance will be happy to see this. Operationally he can do 3 things.
He can buy his puts at the cheaper prices which lowers his operational/ cost and makes his RoR targets easier to attain. Second, he can choose to not buy the puts at all because he believes that low volatility implies the market will go higher. Lastly, he can do a total kool-aid trade by buying more stock and under-hedge his risk. All things area function of the Fed either materially or psychologically making equities easier to own.
Bonus: When the PPT sells puts someone is buying them. Usually marketmaker professionals. These people will BUY stock to hedge their directional exposure as part of their business model.
So, if the Fed sells puts to a professional marketmaker , that market maker will be a natural buyer of stock which materially boosts prices. This is no small contributor to the buying in equities.
Finally and much more Wonkish:
Skip this if you’ve no interest in options and volatility as their own asset classes.
Making puts available (or Vix futures) in a wash-out kills the stochastic process implied by the S& P volatility smile. Meaning, the put skew exists because the market is dominated by “producers” specifically investors as natural longs. A put skew has a strong correlation with an increase in ATM vol if the market drops, and a decrease if the market rallies. Skews have strong correlations with the underlying’s stochastic process of volatility. If that process is stomped on by a Fed put seller, then the skew is unjustified. So, a skew spec should sell puts, buy calls, hedge deltas and collect premium if he has faith that the Fed will be there for him selling vol in a wash out. The Fed is an inurance provider in this way. The Fed put is REAL. Wait until the market rallies and vol blows out as call sellers roll higher and then you will see the skew reverse. Then the market will be completely broken as the Fed will have made it “end user” dominated by being the entity that is consistently bullish and an unfillable buyer (by selling puts now, and by buying stocks possibly later).
Why are we not doing that? Because we would be open to the same systemic risk that the rest of the world is if we did this trade in 1 market. To be comfortable it would have to be replicated across other markets starting in EU stocks for reasons we will not go into here. But it is a good bet that IF the US becomes stock buyers and possibly call buyers once inflation is the issue ad nthey have run out of bonds to buy. This will create the next “Front Run the Fed’s Flow” opportunity. Just Sayin’
For purposes of this article, someone is doing what we describe. And that is one more entity that is leaning on the broken market, adding to the systemic risk created by the Feds’ incentivizing mal-investment and killing the natural market clearing mechanisms associated with a diverse counterparty universe and economic cycles.
The result is a sense of complacency in the markets. This is a FALSE sense of complacency if one were to note the divergence in the Vix (manipulated) vs the ECU ( not so much) starting in 2012
The Broken Markets of 2012- 2017
The result is a sense of complacency in the markets. This is a FALSE
sense of complacency if one were to note the divergence in the Vix
(manipulated) vs the ECU ( not so much) starting in 2012
Note how the spikes in the EPU cease being mirrored by the Vix right after the late 2011. The Vix is still positively correlated, but the magnitude drops markedly. So does Gold’s incidentally. This causes complacency in equity longs. And we contend it coincides with the lack of interest in Gold which started in 2012. Gold peaked in 2011. Some point out that Gold’s average annual price was actually higher in 2012. This makes the correlation with Vix manipulation cleaner. We think that is semantics. This 2011-2012 difference is largely academic we feel. We do not need that 2012/ 2012 perfect coincidence to augment the larger one.
Here is the larger one. The Fed’s PPT did it.
Mal-Investment is Good Investment
As the Vix was suppressed, it incentivized people to put on more risk in equities. That hurt gold on a cash flow basis from both the Vix and the stock market stealing investment money.
- Cheap Vix is cheap insurance: Buy Vix puts for insurance which is more liquid, buy less Gold
- Low Risk means Discretionary money Buys More stocks: Stocks become even more competitive with Gold for discretionary capital.
And Voila! Gold Sucks by manipulation of the Vix.
So: Low Vix > Cheaper Portfolio Insiuance > more buyers of stock AND ViX Puts > Less money in Gold
The Sheeple are not loved by their Fed shepherds.
“Shepherds either f$#k, fleece or eat their flock.” to quote a famous dead polemic. It will end ugly for sure. But not with a bang. It will end with the whimper of tax payers all over the USA. Just ask IL, CT, and NJ taxpayers, the ones that remain.
The risk is now systemic. Remember? The Banks bailed out the Hedge Funds… The Fed Bailed out the Banks… the Taxpayer will bail out the Fed. Here is the answer key.
LTCM > Banks > Fed > TaxPayer > ?????
You the reader, and we the authors, to the extent our observations are believed have to make a decision now. We can accept it and live our lives, rail at it and withdraw from the game, or work within the game and try to get over. We have forfeited our right to claim ignorance.
Math Will Be Repealed
We were all taught that dividing by zero = zero. Remember? Well according to Bon Scott:
The markets can remain broken until the Fed repeals the last law of math.
So for fun we used Google’s calculator to divide by zero. The answer was INFINITY.
Which tells us it wont be long before the ECU is manipulated to match the Vix.
Hope this helps. Read on for more elaborate and eloquent explanation.
Thank you to TD for the original analysis – Deutsche: The Market Broke In 2012, “This Is What Everyone Is Talking About”
Thanks to SRSrocco for applying it to Gold: The Reason Why Gold & Silver Have Frustrated Investors Since 2011
This post originally appeared on Zero Hedge