zaterdag 8 juli 2017

Kevin Muir; The Silver Flash-Crash, "There's No Such Thing As A Bad Tick"

It’s one of those periods when everything is conspiring against precious metals. For those of the bullish persuasion, this can be a difficult time. I have resorted to wearing my own self-imposed “cone of precious metal trading” in an attempt to stop me from buying too much, too early. Let’s review why this environment is so problematic for gold and silver. The main reason is that the global backup in interest rates is about the worst thing you could ask for. Think about it for a second. Central Banks are signaling they want tighter monetary policy because they are worried about future inflation running too hot. They are in essence behaving marginally more prudently. For all those hard money advocates that have been railing against irresponsible Central Banks, they now have less to complain about. Gold has often been called the anti-Central Bank asset, and although many would argue Central Bank policies are still a long way from appropriate, trading is all about the direction of change, and there can be no denying that Central Banks are becoming more hawkish, not the other way round. Central Banks are sending real rates higher. In the process, they are sucking money out of precious metals, and into short dated fixed income securities. Look at US 5 year TIPs yields, they are pushing to new highs...


In fact, given the relationship between US 5 year TIPs yields and gold, it looks like our little yellow friend could still be vulnerable to further declines. Although this global backup in yields is the main factor weighing on precious metal prices, there is another more complicated dynamic at play. And I think this relationship had something to do with last night’s silver flash crash. Last night at 6 o’clock, someone wandered into the silver futures pit and sent silver down almost 11% almost instantaneously...


At first, I thought someone fat fingered it. But when the bounce was weak, it quickly became obvious that no one needed to buy back their error. We had a saying on our old trading desk, “there is no such thing as a bad tick.” What we meant with that expression was that if the market allowed a seemingly violent tick to occur, it often indicated this was the path of least resistance. Many times that supposedly bad tick would be traded legitimately in the coming sessions. It is my understanding the CME ruled yesterday’s silver flash crash excessive, and repriced all trades below $15.45 to this more fair price. Well ironically enough, although last night silver bounced back to $16, this morning in the aftermath of the flash crash, silver traded down below last night’s adjusted low, proving once again, there is no such thing as a bad tick. But this doesn’t explain why someone would choose to sell a whack of silver futures at 6pm. It wasn’t like it was a badly traded 100 lot. More than 6,000 futures traded.
# Why on earth would anyone need to sell almost half a billion dollars of silver at the most illiquid time of the day? It almost makes me sympathetic to the tinfoil hat wearing precious metal bulls who are convinced governments are nefariously conspiring to keep gold and silver down. However, I am an ardent subscriber to the Hanlon’s Razor theory of trading - never attribute to malice that which is adequately explained by stupidity. I don’t think governments are trying to keep precious metals low for some nefarious reason, but I do believe that they are involved. And the following explanation might move me into the tinfoil hat crowd, but I have watched the strong relationship between the Yen and precious metals for too long to believe it is a coincidence. Somehow, and I am not sure of the exact details, the Japanese government is using precious metals as part of their monetary policy. Now they might be doing it through the Postal Service Pension plan (GPIF) - after all, they have openly admitted to the BoJ buying JGBs from the plan, and the postal service pension investing in foreign stocks with the proceeds. There might be some sort of similar arrangement with precious metals. Who knows? I certainly don’t, but I just don’t believe this tight relationship can be explained by chance...


I also think that government officials are the only ones price insensitive enough that they are willing to transact monstrous size at 6pm. But here is the kicker as to why I believe this order somehow emanates out of Tokyo. The 6pm silver flash crash coincided with the opening of the Japanese bond market. That in of itself is not that insightful. But yesterday with the global rout in bonds pressuring JGBs, the 10 year bond bumped up against the BoJ’s 0.10% ceiling. Don’t forget, whereas most Central Banks engage in quantitative easing where they commit to buying a certain amount of bonds at any price, the BoJ has moved to pegging the long end of the yield curve. This means they have to theoretically buy an unlimited amount of bonds at that rate to ensure that part of the curve does not go any higher...


And sure enough, last night the BoJ wandered into the bond market and said, “11 basis points bid for whatever you want to do.” This obviously sent the Yen lower, after all, this transaction increases the supply of Yen, so it is extremely Yen bearish. But more importantly, it was at this point that silver shit the bed. Now maybe this is just one of the consequences of this elaborate financially intertwined science experiment of a new global economy. Maybe there was no silver order from Tokyo. Maybe it was just a domino effect. But I somehow doubt it. Someone still needed to sell 6 thousand contracts. And not only that, they needed to sell them in the stupidest way. And when I am looking for culprits for stupid, Japanese government officials seem like the most likely candidates. However, putting away my cockamamie theories, I want to point out one important indisputable fact. The BoJ has committed to pegging their 10 year rate to 0%. If the global bond bear market gathers speed to the downside (higher yields), then the Japanese will increasingly find themselves having to defend this peg. As they defend it, this will increase the money supply, which will ultimately be inflationary. That might force more JGB holders to sell, creating a self reinforcing vicious circle. The Japanese have relinquished control of their money supply. If credit is demanded, they are forced to provide it in unlimited quantities.
Over the short run, this might cause precious metals to go even lower, and stocks might gain as the BoJ’s printed money finds its way into risky assets. Yet eventually this will become a dangerous game to play and I suspect it will prove an unstable equilibrium. Last night, talking it over with my trader pal Ari Pine, he told me that he thinks a likely candidate for the next flash crash might be the Japanese Yen. I can’t say I disagree. All the ingredients are in place. Think about buying some volatility in non-equity instruments. Stocks are a sideshow for the real disturbances in the financial system. Central Banks have been suppressing bond volatility for so long, and as the financial system weans itself off the constant quantitative easing of the past decade, there are going to be some large moves. Silver volatility was relatively inexpensive yesterday. Today, after the flash crash, it’s not as cheap. Some day soon, we might be looking back at Yen vol, or US long bond vol, or gold vol after the next flash crash, and be kicking ourselves that we didn’t buy it when we could....