What Next for Gold and Silver?

On Friday morning there was impressive sell-off for precious metals, leading to a two day decline that was the largest in 30 years.  Gold fell from 1552 to 1325 and Silver fell from 27.60 to 22.10, a 14.6% and 19.9% drop in the course of two days.

As I write this, midway though day 3, prices have stabilized a bit, recovering about 1/5 of what was lost on Friday and Monday.

ZeroHedge points out the recent move for Gold was a 7-sigma event.  Assuming a normal distribution, that means there is a 0.0000019% chance of an week like this occurring given the price action over the last ten years.




So, what on earth is happening?

The most common story that we've heard is that a massive sell order of 4 million ounces hit the market at the open of US trading, routed through the Merrill desk.  So whoever it was that was selling was clearly trying to move the market -- as you would take an entirely different approach if you trying to unload that much at a decent price.  That massive trade was approximately $6 B worth of futures, which took approximately $1 B of initial margin to start (if it was new position).  Over the morning, over 400 tonnes were traded which is equal to 15% of the annual production of gold.  What happened over the weekend and on Monday is that margin calls brought substantial pressure on the precious metals market.

It didn't help that given the price volatility, both the Shanghai Gold Exchange and CME raised margin requirements by 15%+ on Sunday and Monday.  This, as you would expect, put additional pressure on metals prices due to market participants needing to pear back positions to meet margin requirements.

It's a little bit surprising that how much effect that a $1B trade can have on a such a liquid market like gold.

So what's next?

My gut feeling is that the $1B shot on Friday was guns blazing and that whoever threw that wrench into the system is spent.  I would imagine that any follow-on attempts would be less impactful, since the marginal hands have been emptied.  I believe this to be a local bottom for the metals.