The postmortem for last week’s historic gold price collapse continues.
Art Cashin, UBS Financial Services’ Director of Floor Operations, passed along a theory tied to the world of structured financial products.
In short, a structured product is an investment vehicle that gives the client tailored exposure to the markets. It usually employs derivatives like options and swaps.
In his note this morning, Cashin advances the idea that pension funds invested in structured products tied to gold had safeguards in place that would force these products to unwind should the price of gold fall below $1,530/oz.
Was There A Mystery Guest At Last Week’s Gold Massacre? – As you may recall, the Friday/Monday gold massacre, had more than a few strange aspects. As prices plunged in the pits, gold coin shops were said to be swamped with near record demand.
The puzzles and conspiracy theories were still very much alive on Wednesday, the 17th, when, in a pre-dawn interview on CNBC, Brian Reynolds of Rosenblatt Securities suggested, rather matter of factly, that a good deal of the carnage in gold might have come from the unwinding of some “structured products” held by pension funds.
Fascinated, I reached out to Brian to learn more about how structured products (big in the mortgage meltdown) were suddenly adding leverage (and danger) to the gold market.
Apparently, it all starts with an old familiar premise – pension funds and others are desperate for yield and greater return in this ongoing age of QE and zero interest rates.
Say oil has averaged $95 over weeks or months. The wizards might structure kick-out triggers at, perhaps, $75 and $115. Should oil fall below $75, the structured contract would terminate, leaving the issuing bank with an unexpected, and unwelcome position in oil, in a falling market. Reynolds says the urge to dump that position is compounded by balance sheet limits in Dodd-Frank.
OK, back to gold. Here is what Brian wrote, somewhat prophetically, back on February 21st, long before the waterfall in gold began:
The caps and floors associated with structured finance tend to leave participants long or short at the worst possible time. We remind people that there are likely caps and floors associated with structured finance positions in gold around the 1530 and 1800 areas, so it should not be unusual to see rumours pick up as the metal nears those areas. If the floor gets broken decisively, participants may find themselves unexpectedly long, and rush to quickly dispose of those unwanted positions.
When gold broke through 1530, the cascade began. How much of the freefall had to do with structured products? No way to tell just yet. We’re still digging. It’s a topic worth pursuing since the Bank for International Settlements says the value of commodity related contracts may be in the multi-trillions.