Fed sticks to their plan as the gold price falls

Shae Russell:

Welcome to The Pod of Gold, where we talk all things precious metals and their markets. Today, we discuss the tilt of positioning behind gold, some bullish price targets for silver, and why the Fed didn't want to spook the market overnight.

Plus, we have an update on China's property sector, as well as a look at the LMEs day of reckoning with nickel contracts.

I'm your host, Shae Russell. And joining me today is precious metals expert Nick Frappell from ABC Refinery.

Nick, how are you mate?

Nick Frappell:
Very well. Thank you, Shae. Very well, lots to talk about today, I'm so sure.

Shae Russell:
Yes, it's been an incredible week. Actually, it's been an incredible three weeks, it's given us plenty of material to cover. So, let's kick off.

Now, first of all, I do want to reflect on gold's behavior in the past two weeks. If we look back to only 14 days ago, spot gold was trading at $19.24 per ounce. It's back around that now at the time of recording today on the 15th of March. However, in between these two periods, spot gold actually rallied up to, I think it was $2071 per ounce, which was nearing the August, 2020 highs.

Now, before we get to the technical picture, I want to first reflect on something you said in our podcast that we recorded on the 20th of February, and that is how difficult gold can be to trade during times like this. Tell me, why is that?

Nick Frappell:
Well, it's basically because geopolitical news, it's a huge back and forth of news impacting the market in quick succession, particularly now with the Russia-Ukraine invasion and that tends to distract from all of the other activities, the real yields, the dollar influences and so on.

So, you get this run up. You also get something which I guess a lot of markets talk about which is buy the rumor, sell the fact. And there was definitely, looking at some of the gold valuation thesis and the preceding three weeks in February, gold had a big run up and then an even bigger run up. But it really, really did reject that previous August to '20 high quite aggressively. And it's just very hard to trade that news flow and also people's interpretation of that news flow. So, that's my take in it. And just looking at previous geopolitical situations where very often people are caught out by big run ups and very big rejections of price levels or profit taking and so on.

Shae Russell:
So, we're probably going to come back to a couple of things you said in there in a moment. But first, not first and foremost, I want to go over managed money and futures positioning. Now, you brought this to my attention on yesterday.

Can you please expand on what you mean when you said there's a tilt in positioning that you are witnessing in gold right now?

Nick Frappell:
Yeah. It's interesting actually because if you look at managed money futures only as we always do, then you saw evidence of liquidation by the longs in the week ending the 8th of March. And since then open interest has dropped even further, dropped about 2.1 million ounces from Tuesday the 8th to Tuesday the 15th from the data I can see.

What's quite interesting is kind of like a little twist on that and this was drawn to my attention by a friend of mine in Singapore whose opinion I value greatly, is that if you look at the combined futures and options in managed money long position, that's actually grown by quite a lot. So, what it looks like is that the longs that got in and really, really great volume weighted averages in the preceding two or three weeks, what those entities are doing is that they're willing to sell out the futures long, but then park some of that money into the options calls.

Nick Frappell:
That enables them to participate in the upside but it means that they don't necessarily if the market whips down, what they've lost is, if indeed they have lost it, but the maximum they stand to lose is the premium they paid for the options. They can kind of take a slight backseat if you like and say, "Well, we've still got that upside participation." If it doesn't happen, we know what the downside is and we can park that if you like. Option strikes, if you look at the increase in the open interest in particular option strikes October 2050s, October 2075s, some really, really low Delta, I think August 2375s, but over the last week, since Tuesday the eighth, most active call strikes, basically 2100s, 2200s, we're going to call them all out.

Nick Frappell:
Obviously calls dominating over puts. One of the things is that depending on where Tuesday is settled, you might see all of the things being equal. You might actually see a change in the futures and options combined positioning even if managed money don't add or subtract from those positions because as the price changes, the actual Delta adjusted size of the position changes even if you don't add or subtract it. So, that seem to bear in mind. But I suspect that given where it depends where the valuation came in basically.

Shae Russell:
My next question that I want to go through-

Nick Frappell:
We always like talking and playing English on this podcast, aren't we?

Shae Russell:
Yeah. Anybody who's new to the markets probably didn't understand most of what you said just then. That's okay. Now look, I have in very big, bold highlighter on my run sheet, do not forget to talk about the cloud. So, we are going to about gold's recent movements within the weekly cloud and what it says, but I want to lead into that question first with a private note, you show private a conversation you and I shared in private last week, whereas just as gold was nudging those August, 2020 highs, you sent me a screenshot of a good old candle stick chart with a really long shadow and you said, "I think there's a reversal on the cards." So, and that was quite forward thinking because there were some big calls being made for gold at the time. So, not only did you call the reversal base on this candlestick chart, but since gold has fallen, tell me what does the Ichimoku Cloud tell us about gold right now?

Nick Frappell:
Well, yeah. The candlestick formation that we were looking at, and it was a little bit ahead of time because obviously the time zone difference here are weekends before the fair bit. There's plenty that can happen between the close of our Friday and the close of an American Friday, which is really what we're looking at, but already the gold on the weekly, gold in US dollars on weekly had formed a really, really notable shooting star, which is a sort of one candle reversal, hint of a signal that has to be confirmed and absolutely this week it was confirmed. It was confirmed way more than I expected in the sense that sort of very easy to catch falling knife in that kind of market, but went to sub 1900. And so, a tremendous move already given that it's only the beginning of Thursday, well it's Thursday here now. In terms of where the clouds, the price is still significantly higher than the daily Ichimoku Cloud. So, that enables or allows for some further downside.

Shae Russell:
Now, for all those silver fans out there, we can't move forward without talking about the other precious metal. Similar to gold, silver has been on a wild ride in the past two weeks while it nudged $27 per ounce, I think a near nine month high. With silver falling back down to 25.12 at the time of recording, it's pretty much back to where it started on March two, much like gold give or take a few cents. So, what I want to know Nick is has this price movement in silver, has this changed the technical picture for silver going forward?

Nick Frappell:
It certainly improved it although the move back down to the weekly cloud base is not too positive. The market made a high of almost 27 bucks as you said, formed a doji candle which speaks of either uncertainty or potential trend reversal right at the weekly cloud top, which is key resistance. From my view on silver, the important thing is to stay above 21.5, say US dollars. And above that level list of the patterns we're seeing enable fresh targets or fresh targets that exist now to 29.31 which is certainly above that level, look for those targets to emerge over time. Silver positioning again, by the end of March, 8th of March had risen almost 24 million ounce. So, not as strong pickup in buying from futures as the week before, but again, little bit of short covering, just small amount of short covering from the shorts.

Nick Frappell:
So, overall positive, if you look the change in open interest since then though, I think there's been about a 43 million ounce decline in open interest if my unreliable notes can be relied upon. So, there's clearly been some long liquidation in that period as you'd anticipate.

Shae Russell:
Now you put out some pretty bullish silver targets there from your trust point and figure no doubt. Tell me, are there any downside levels?

Nick Frappell:
Yeah, look there are, there are quite significant ones actually, but the thing is, and then those downside targets arise from the fairly strong moves from the previous recent highs and those downside targets are still in place. I don't tend to pay a huge amount of, not that I don't give them credence, but we are still in what looks like a intermediate uptrending market. And one of the downside targets, well, the reasonable downside targets are round about 22 in [inaudible 00:11:01] and thereabouts. But if you want to look at for the sake of fairness and objectivity big downside targets, there is one to 14.75. Now silver can and will do almost anything it likes, but at the moment time given where we are price wise, I'm more inclined to put my money on the 29 and 31 level, rather than the 14.75. And as we go higher again, of course, that downside target eventually gets knocked out and maybe next week, I'll mention where the actual lock out point is.

Shae Russell:
Nick, that is my new favorite saying silver can and will do almost anything it likes. And I think that sums up anyone who has tried to trade, it sums up the experience of anybody who has ever tried to trade silver.

Nick Frappell:
Tell me.

Shae Russell:
Now we are going to switch. Yeah, you might be speaking from experience there. Now we are going to, if I don't throw my pen around, we are going to switch gears. We're going to move to the meatier topic of today's conversation. Now in the macro part of today's conversation, we will be looking at some old friends. We're going to cover the Federal Reserve, Chinese property prices, and also too we're going to take a quick look at the chaos in nickel trading that last week. First and foremost, let's start with the Fed. Now, as we discussed yesterday through with the Federal Reserve, we're talking about at the end of the FMOC, and really the Fed had two options.

Shae Russell:
And that was either to do what's expected, which was to increase the cash rate by 25 basis points or the unexpected, which was to increase by 50 basis points. Now we've woken up this morning to the news that the Feds decided not to spook the market and they've opted for a 0.25% increase. So, what I want to do from here is rather than focus on the start of tightening from the Fed, I'd like to discuss the overall tightening cycle. So, tell me with the lower basis point increase, has this changed the future of rate rises from the Federal Reserve?

Nick Frappell:
I don't think so overall. I think there are still an expectation of about six overall. I think yesterday when we were talking about this, there was only a one in 25 probability attached to a 50 basis point rise which had been something that had been put out there by some of the senior Fed people two months ago. What is it is fair to say, if you start looking at, say, July, expectations around July, there's a higher probability attached now to a 150-175 range for Fed funds and a lower probability attached to the 100, the next band down the a 100 and to 125.

Nick Frappell:
So, the middle to higher bands are the market is pricing a higher probability. So yeah, 25 basis points gentle and expected liftoff, probably not likely to see a significant change. I think the ending target rate, which was thought to be most likely around two and a half percent is now considered say by the end of 2023, to be 2.375%, that's an eighth less. I would say, given that everything that's going on in the world, that's not a significant difference at all. The other moving part in that is that if inflation which looks some pretty bad numbers out there, higher and continuing inflation will only change that sort of outcome and make the chances of a higher and tighter more and more likely. But effectively to answer your question, Fed tightening cycle might have started at 25, not at 50 on the opening move with QT, I think expected to commence around about May. It seems to be fairly well communicated, but the overall tightening expectations through the cycle do not look as though they will be significantly affected.

Shae Russell:
All right. The sleeping giant, that is China's property market. Now in spite of recent geopolitical events, China's property woes or China's property sector woes have continued to unravel. Now there's been some more data on the matter that's come through recently and you've had a chance to digest it. While our attention has been diverted to bigger headlines, what have you seen shift in the Chinese property sector and is the problem still as big as it potentially was looking last year?

Nick Frappell:
Yeah. I think it still is big and it's not going away as reading one piece of commentary which said that if you count them all up, there are 44 measures that the Chinese government has taken in order to try and support or boost in some way or another the domestic property market. The market is still seeing significant drops in home sales. I think 22% year on year in January and February, that is significant. Prices are beginning to soften. There's as usual, these things there's sort of two steps forward, one backwards or two forward and three backward, but prices are softening. And I think you could generalize the issue and this is happening elsewhere is that this is an asset class where potential new buyers or buyers who wish to add to their holdings are now thinking this is not an asset class they want to be associated with.

Nick Frappell:
So, they're stepping back and they're expecting lower prices from developers if they are going to move forward with a purchase. So, given the scale of the Chinese property market within the hold of the Chinese economy which is something we discussed last year and this was much more front and center, that's still got to be a significant drag on the economy going forward. And significant source of concern, not only to the Chinese property companies which are at the epicenter, but also the banks that finance them, and the local government authorities and the provinces that rely on finance from land sales. So, there's a whole degree of interconnectedness there which can play out quite badly.

Nick Frappell:
But saying that recent Chinese data has not been too terrible, the thing that the vulnerabilities that I see alongside the property market are rising youth unemployment and which I think if I also should have to pay [inaudible 00:18:07] is 16% for the sub 24 year old age group. And also of course, of vulnerability to rising food prices. But yeah, this I had hope to have a little bit more data in terms of we can see that the high yield bonds are just absolutely cratering, huge volatility in the Hang Seng as connect relate one of the things that's driving that, but I see some sort of evidence as well of some stress elsewhere in the financing piece as well. I can summarize it like this, actually. I think [inaudible 00:18:47].

Shae Russell:
Now Nick, we cannot have a podcast this week without discussing the drama that occurred on the London Metals Exchange last week, where the nickel price doubled in just a few hours to reach a $100,000 per ton, I believe causing the LME to halt nickel trading. Now, nickel resume trading on the LME this morning though I believe the chaos is continuing as circuit breakers were triggered in the early hours of trading. But once again, here's where I want to tap into your multi decade experience as a trader. Now, granted you are precious metals, not base, but you have witnessed this type of stress before on a commodity exchange. So, tell me, what is your experience with this and how can we relate this experience to the turmoil in nickel on the LME?

Nick Frappell:
Well, the really important thing is not just that the LME suspended the nickel contract for a few days, but actually it also, it canceled trades that various counterparties believed that entered in good faith at one of the world's key forum for price discovery in metals. So, the period over which those transactions were canceled, where the price, I think, went from the previous Friday's close of 50,000, $55,000 a ton up to a $100,000, there was significant volume taking place during that trading period. And what that tells you is that people were significant, people were very keen to transact. Some of those people might be in great pain, but nonetheless there was real business. It wasn't like a fat finger or a faulty print or a someone traded one lot at an incredible price and that set the whole thing.

Nick Frappell:
There was days of volume going through in a very short time period. Now, without going into too much the technicalities, the broad take on this is that no exchange ever wants to find itself in a position where it appears that one group of risk takers have been privileged over another group. And the experience that you mentioned in the [inaudible 00:21:09] to this was back at the just post 2000, whatever or when the palladium contract in [inaudible 00:21:18] jammed and it jammed for design reasons, the price rose overnight because the market was being squeezed, going to Russian supply issues, so a little bit of a historic echo there. And then when the [inaudible 00:21:30] contract opened the following day in early Japan time, early Tokyo time, it opened at a level where the market was automatically limit up and therefore those significant shorts on the exchange could not get out, which was really horrible for them and it kept on happening over several days.

Nick Frappell:
And I think in the end, [inaudible 00:21:48] after much soul searching, let those shorts out at a much lower historic price, but of course, in doing so, they naturally penalized those who had been long and right to be long. So, that was something that caused a lot of anger and upset as you would expect it to. And no doubt, well, we know that the LME's decision has done the same. The long term effects of that is that it risks the liquidity, the long term liquidity and the long term, the desire of participants to trade on that particular forum. In this case, the LME nickel contract, it affects their interest and their willingness to do so over the long term. So, it might not be a disaster. Well, it might not be these effects can take a while to work out, but it's not good that people weren't able, even at the expense, the potential bankruptcy of a party.

Nick Frappell:
Now, I'm just going to go on about that because I had hoped to have an idea of how much nickel Tsingshan, some nickel group can make in a year. But ultimately one of the positive things that of course is that they are a nickel producer. They are short to hedge their future and existing nickel output so they can deliver into those positions. The critical thing is can they meet their margin calls? The principle banks that broke Tsingshan's business have agreed that rather than go through the, you can't meet the margin call argument and stopping them out entirely, it would be better to fund their margin call shortfall and fund it until Tsingshan can produce the nickel that they can deliver into those shorts which is in the end a major win for the nickel short and probably a better outcome for anyone who's on the hook to them.

Nick Frappell:
So, they do have something to deliver into. So, in that sense, bit of a different story. This is more of a liquidity gap in terms of that entity being able to meet some obviously huge margin calls. Probably if you had the wisdom of Dr. Hindsight, which everyone has that wisdom at least some of the time, then what was ideal is when you see really large publicly viewable positions like that, you can't tell that something is going to kick off in with between Russia and Ukraine that will create a commodity sort of crisis. But even when positions are already extended like that, you can actually increase the margin payable on outstanding positions and that of course gives everybody who's got those large positions an economic incentive to revisit them and think, do I need to be that?

Nick Frappell:
Does my bets need to be that large? Of course not a total bet because he's long already, or he's a producer, but nonetheless, it gives you the opportunity for people to sort of think, "Am I doing the right thing here? It's costing me more to have this position." And that's perhaps one of the things that should have come up. I don't want to sort of second guess things like that entirely because if you're not there, you can't tell exactly what's going on, but in a perfect world, you probably start turning the thumb screws a bit when people have such large positions to say, "Okay, we're going to make this incentivize you to think harder about it."

Shae Russell:
All right. Nick, that is a fantastic answer and some great insights there on what happened on the LME last week. And Nick, unfortunately though our time has drawn to a close.

Nick Frappell:
We've run out of time.

Shae Russell:
We have run out of time. So, Nick as usual, I just want to say, thank you very much for being here. I look forward to the next one.

Nick Frappell:
Absolutely. Same here Shae, and we'll speak again very shortly.

Shae Russell:
Thanks for listening. To get a better understanding of the technical indicator Nick uses, the Ichimoku Cloud, it's available on most trading platforms. Alternatively, you can check out the show notes over at abcrefinery.com/podcast. Here you can sign up to receive more information from Nick Frappell, including his monthly report, where he incorporates technical analysis alongside Macromark commentary. That's all from ABC Refinery. We look forward to you joining us next time.