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Analysis: Lurching gold prices mystify traders, undermine confidence

Jewelry made from gold is laid out at Zorka, a jewelry factory, in Minsk April 26, 2012. REUTERS/Vasily Fedosenko
Jewelry made from gold is laid out at Zorka, a jewelry factory, in Minsk April 26, 2012. REUTERS/Vasily Fedosenko

By Frank Tang

NEW YORK (Reuters) - In the early hours of the New York morning on Thursday, when scarcely a few hundred lots of gold futures are usually traded, a wave of buy orders worth over $2.3 billion surged into the market.

Prices soared 3 percent in just 10 minutes, setting the tone for the next 12 hours of trade - and puzzling many traders and investors who have been rattled by a series of similarly abrupt, and largely unexplained, trade surges over the past two weeks.

While sudden swings in the price of gold are nothing new, the usual causes - a shock in economic data or a "fat finger" erroneous trade - don't seem to fit. While the U.S. dollar had also tumbled on Thursday, bullion's move was far more extreme.

Some are pointing at spin offs from today's predominantly 24-hour electronic trading, with a far smaller number of market makers on the trading floor to match orders and provide liquidity.

The half-dozen mammoth orders whipsawed prices and disrupted trade in the CME Group's Comex futures, a market already edgy about bullion's fading safe-haven appeal and its lackluster performance during the U.S. budget impasse.

"What's unusual about these moves is the price stays at a new level so that suggests it's a natural buyer or seller," Chris Concannon, executive VP of New York-based electronic trader Virtu Financial.

"This is moving to and setting a new price level, so it can only be done by someone who's buying or selling substantial amounts and then holding."

Unlike the meteoric declines in April and June, when institutional investors exited en masse in a two-day sell-off, these seemingly sporadic trades lasted only minutes but overwhelmed volumes and price direction on each occasion.

The barrages started on the first day of the U.S. government shutdown, yet seemed to bear no link to the headlines from Washington. Other financial markets have remained mostly immune to gold's erratic trades.

Traders have offered a host of possible explanations including that it could be driven by selling by a distressed fund, yet the incidents have occurred across a period of nearly three weeks.

Others said it may be due to unusually low liquidity, as open interest dwindled to a four-year lows just a day before the first episode on October 1. But professional Comex traders should know to moderate their orders in thinner conditions.

A few suggested darker causes: the deliberate gaming of the market, whether by a rogue trader or a computer-driven algorithm that seeks to maximize market impact by overwhelming the system with a large number of orders in milliseconds.

Whatever the cause, the trades risk undermining confidence at a time when electronic trading glitches and flash crashes have roiled other U.S. financial markets in recent years and will fuel concerns that algorithmic trading systems have undue influence over prices.

"Clearly, whoever is out to sell is looking for high impact. It's somebody who is either running a big short position or would like to see a lower gold price for other reasons," said Ross Norman, Chief Executive Officer of London-based bullion broker Sharps Pixley, referring to an abrupt $30 drop on Oct 11.

4:00 A.M. START

Thursday's roiling started just after 4:00 a.m. EDT (0800 GMT), when almost 18,000 lots, equivalent to 1.782 million ounces of gold, changed hands in a 10-minute interval, sending gold futures up 3 percent to their highest in just over a week.

December futures ended the day up 2.7 percent at $1,319 per ounce.

(For a graphic see: http://link.reuters.com/fut83v )

One possible explanation: short covering after U.S. lawmakers agreed an eleventh hour deal that reopened government and averted a debt crisis for the world's largest economy. The U.S. dollar had just tumbled, also with little cause.

The episode followed five equally dramatic and short spurts of heavy buying or selling that moved prices by over $10 within minutes.

The sheer volume has astonished traders.

On October 1 and October 11, volume in just ten minutes exceeded 20,000 lots, accounting for almost a tenth of the market's average daily turnover this year, Reuters data showed.

Two of those incidents triggered the CME Group's rarely-used "stop logic" function that automatically halts trade briefly to prevent excessive price movements.

CASCADING ORDERS

One common phenomenon that may be exacerbating the sudden swings is cascading stop orders, a condition in which a big move triggers stop orders which in turn cause the market to set off other stop orders and inappropriately moves the market.

Traders say that these cascading stop orders are a side effect of today's electronic trade.

Over the last few weeks, in a market lacking the usual flow of U.S. government data that often defines the day's trade, such technical trading may have held more sway.

"In essence, a lot of market participants are placing similar orders at the same price, as everybody is looking at the same chart and the stops build in a particular price," said Frank McGhee, head precious metals dealer at Chicago commodities brokerage Alliance Financial LLC.

It's not clear if these dramatic trades will have a long lasting impact on prices, but traders warn they could damage investors' confidence in the long run.

"It's just the reality of electronic trading," McGhee said.

(Additional reporting by Clara Denina, Jan Harvey in London and Josephine Mason in New York; Editing by Josephine Mason and Ed Davies)

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