- Created on Thursday, 06 October 2011 07:00
- Published on Thursday, 06 October 2011 07:00
- Written by Justice Litle, Editor, Inside Investing Daily
- Hits: 11396
Does the heavy sell-off change the picture for gold, or is the metal still worth holding?
When it comes to the bull market in gold, occasional volatility is part of the deal. You can't reach a long-term destination without price declines... sometimes big ones.
But on the morning of Monday, Sept. 26, something fishy happened. The price of gold dropped a stunning $130 per ounce during Asian trading hours, before the U.S markets opened.
The yellow metal recovered from that blow, leaving a nasty spike on the overnight charts. But many wondered what such a huge move was all about.
"The break has provoked a great deal of suspicion," says Peter Brimelow of MarketWatch. In other words: Could gold have been the victim of a hit and run?
Via Brimelow, U.K. gold dealer Ross Norman adds:
Placing such a huge order into the market when the least number of market participants were active tells you that they were out for dramatic effect. Anyone looking to offload significant amounts of metal at the best possible price would have done so when both London and New York were both [open]. ... Clearly finessing gold into the market was not their motive -- they wanted a statement.
Nomura, a Japanese investment bank, put out a research note explaining the connection between Asian trading hours and the price of gold. In recent weeks, Nomura says, "price action during Asian hours has become very bearish, which had not been the case in previous unwinds earlier in the year."
This naturally leads to questions. Who has been selling? And has the outlook for gold changed?
To some extent, gold had become a victim of its own popularity. As the metal kept rising, sentiment matched that of a popular stock. GLD, the best-known gold vehicle, at one point became the largest ETF in the world. Hedge funds and other leveraged speculators were patting themselves on the back for holding it.
Then, in the aftermath of the Fed's "Operation Twist" in late September -- which might as well have been called "Operation Useless" -- stocks fell hard, and gold fell alongside.
There were macro-level reasons why gold fell out of bed. The U.S. dollar displayed newfound strength, deflation fears were back, and inflation expectations had hit their lowest levels in a year.
But more than likely, the selling was just overaggressive buyers facing margin calls (with margin requirements hiked repeatedly) and shell-shocked fund managers cleaning house. Profitable gold holdings became a prime source for cash.
Says Michael Gayed, chief investment strategist of Pension Partners: "The tendency for individual hedge funds or anybody is to sell winners before they sell losers. What's been one of the few winners this year? It's been gold."
Being popular isn't always what it's cracked up to be. The important thing moving forward, though, is where gold goes from here. Have the core reasons for holding gold been invalidated?
Central banks around the world are still woefully exposed to paper currency, holding far too many dollars as a portion of reserves. (And now they are forced to wonder about their euros.)
The root problems of the financial crisis have not been solved. If anything they have been made worse.
The ultimate "solutions" to Europe boil down to post-breakup catastrophe (the destruction of the euro), a Hail Mary implementation of the printing press (via eurobonds), a mass bailout of Europe's banks... or some combination of all three.
The Keynesian table-pounders -- those who argue we need more stimulus, more leverage, more government debt -- are as insistent as ever, and will grow even more insistent as economic conditions deteriorate.
Gold could decline further in the coming weeks as money managers liquidate. In trading desk terms, this reflects the possibility of "weak hands" being washed out. It's hard to say how long the washing out process will take, and it could end as quickly as it began.
Ultimately, those with a keen interest in accumulating large amounts of gold at a favorable average price -- such as the world's central banks -- will not be able to resist the temptation. The long-term motives are intact, and shady motives for manipulating gold lower are no match for the fundamentals.
Last but not least, as for the Asian selling, Nomura closes on a bullish note:
We think that a reversal of this trend back to gold appreciation in Asian hours is the key to a short term reversal and we have begun to see this in recent days[...] We continue to view long-term fundamentals, such as low real rates and the relative cheapness of gold when viewed from an Asian perspective, as bullish for gold.