With all the discussion of the crash of April 12-15, I thought it would be interesting to do a little forensic analysis. Instead of looking at price graphs, let’s look at a graph of the gold basis. Contrary to the currently popular assertion that the gold price crashed due to manipulation, the evidence points to something else. The question of whether gold is manipulated by the “naked” selling of futures, or whether other forces are responsible for gross price movements, is important to anyone who wants to trade the metal.
For a quick tutorial, the basis and cobasis are spreads between the spot price of the metal and the price of a futures contract. Basis is the profit one could make to carry the metal, which is to simultaneously buy the physical metal (at the ask) and sell a future (on the bid). Basis = Future(bid) – Spot(ask). Cobasis is the profit one could make to decarry, which is to sell physical and buy the future. Cobasis = Spot(bid) – Future(ask). Basis and cobasis are quoted as annualized percentages, so they can be compared to other yield opportunities in the market.
Carrying and decarrying are arbitrages. The arbitrager cares about spread and changes in spread, not about price or changes in price.
Here is a graph showing the long term basis and cobasis curves for Apr 11 before the crash, the 12th the first day of the crash, the 15th the second day, and the 16th the day after. Each line represents one full basis curve from present through the end of 2016. What we’re interested in, on this graph, is the change from one line to the next, which represents one day to the next.
First, let’s look at the cobasis because it is simpler here. We see volatility only for the June contract. From April 11 to 12, it rose a small amount, then for the remaining days it fell fairly sharply and was no longer in backwardation (backwardation is when the cobasis is positive, i.e. decarrying is profitable, i.e. the physical commodity is scarce). All farther months remained stable. There is no evidence here of massive dumping of futures or of anything else. The fact that the cobasis fell means that the offer on the future rose relative to the bid on spot. The offer on the future was robust during the crash. Make of that what you will.
The more interesting thing to look at on this graph is the basis, and the interesting part is mostly in what changed on April 15. We can hardly see the dark blue line for the 11th because the green line of the 12th is on top of it. This is normal and shows nothing untoward happened on the 12th.
But on the 15th, All Hell Broke Loose.
On the 15th, the basis was collapsing especially for contracts in 2014. Contracts in 2013 and 2015-2016 we affected but not anywhere near to the same degree. The falling basis means the bid on the futures contract dropped.
Whoever normally makes the bid on these distant contracts did not show up to the market that day. One might argue (indeed many gold commentators do argue) that there was massive naked selling of futures contracts. There are four reasons why I do not believe this allegation fits the evidence.
First, the basis is a very small number and a very sensitive indicator. Aside from Apr 15, it is in the vicinity of 0.4% annualized. That is roughly $6 per year (assuming a $1500 per ounce gold price). If the price of gold was smashed down by more than $200 via selling of futures, then the change in the basis would be much, much larger.
Second, as I wrote previously, the open interest did not change much during the time frame, and actually fell from the 12th to the 15th.
Third, by far the largest change in the basis was for the August 2014 contract. For the days in question, there were less than 1000 contracts open and there was minimal trading volume. This is not the contract that would offer leverage to change the gold price.
Finally, the cobasis did play along as it would have in case of futures dumping.
Now that we have discussed what the basis data does not show, let’s look at what it does. First, the cobasis falls on April 15 and the next day as well. It had been above zero—in backwardation—but it fell below zero. This indicates that physical metal came into the market. This pushed down the bid in the spot market. Since cobasis is Spot(bid) – Future(ask), the cobasis fell.
Second, the basis for futures contracts in 2014 (centered around August) dropped precipitously. Since basis is Future(bid) – Spot(ask), we know that the bid on the contracts in 2014 fell. While this could mean that there was concentrated selling, it does not make sense why it would be in such a distant contract with low open interest (and the low volume does not support this theory).
My conclusion is that on April 15, liquidity dried up. Whoever normally makes the bid on these distant contracts did not show up to the market that day. This would fit with a general picture of balance sheet stress and credit contraction (especially in Europe).