Jockeying for Position

Trading in futures has a lot in common with horse racing. It's all about clever maneuvering until right before the finish line. In the vast majority of races, the winner is only marginally better than a handful of other favorites. However, every now and again, there's a real upset with a completely unexpected winner passing the finish line with a sizable margin. That's when things change. Fortunes are made and lost. Odds have to be recalculated. The value of the horses reassessed.

Right until the final seconds of the race, the riders are merely jockeying for position. The great majority of participants are completely unaware of the upset that's about to happen. However, in retrospect, it may be quite clear why things unfolded the way they did. Things may have been changing in the way horses have been trained. A talented jockey may have appeared in the shadows. Those who paid attention to the developments outside the racing track might have known about an imminent upset, and positioned themselves accordingly.

This is similar to what happened on April 20, when the May futures for oil expired. Right up until the very last hours of trading, everything seemed normal. But then, all of a sudden, the price of May contracts went negative. Prices went from 20 dollars to minus 40 dollars, and countless speculators in long positions went bust, while the shorts made an absolute killing.

In retrospect, what happened makes perfect sense. With nowhere to store oil, anyone caught long in these contracts will have to find alternative storage space by April 30. Truckloads of oil will be delivered at the door of contract holders, and they better have ready storage space, or they will be faced with the cost of renting the trucks. There will be fines and fees.

The speculators now holding long contracts, with only days to find storage space, were for some reason ignoring the evidence that was plain to see for everyone involved. They failed to make the connection between what they were doing and the physical reality of the world. Otherwise, they would never have taken on the long contracts in the first place. The problem was that they had become accustomed to thinking of the jockeying as being the entirety of the game. They were so used to rolling over contracts from one month to another that they had forgotten the fine print about oil being delivered to their door unless alternative storage can be found.

This disconnect between futures trading and the underlying reality of things is so widespread that many other markets are likely to see similar upsets in the months ahead. The world has changed, and those who haven't fully understood this are likely to be caught wrong footed.

The gold market is likely to blow up in a similar fashion to what we saw with oil. The only difference being that it will be the shorts who will be caught off guard. When May contracts for gold expire on the April 30, many longs will demand delivery. This is because the world is becoming increasingly uncertain. The risk averse will therefore seek the protection of physical gold. That means that anyone who's short gold, but not in possession of physical gold, may be asked to find this gold on April 30. It will be similar to the oil trucks showing up at the door of oil longs on that same date, but with the big difference being that someone, possibly with a Russian accent, will be asking about his physical gold delivery.

It remains to be seen what happens as we get closer to the expiry date of the May gold contracts. Nothing out of the usual may happen. However, it could also be that the shorts panic in the very last hours of trading, sending gold up several multiples from the current price. If that happens, chances are that the June and July contracts will go up too. Because once there's a general awareness about gold being in short supply, prices will not only have to move higher, they must remain high in order to entice owners of physical gold to sell.

By Noah Salzman - Own work, CC BY-SA 4.0, Link