Taking the Shine off Gold

A dramatic fall in the price of gold has caught many investors by surprise and raised questions over whether a bullish market that had seen prices climb for 12 straight years has ended.

On April 15, gold futures for April delivery plunged US$ 140.4, or 9.4 percent, to US$ 1,360.6 an ounce on the Comex division of the New York Mercantile Exchange. This was after a 4.1 percent decline on April 12, the previous day of trading. The two sessions’ trading combined reduced the price of gold futures by more than US$ 200 an ounce, or 13 percent.

The second day’s fall was the metal’s biggest one-day percentage drop since February 1983. In dollar terms, it was the biggest since January 1980.

Three Chinese analysts trying to identify the cause of the episode have come up with different explanations, ranging from investor panic triggered by the European debt crisis to, more bizarrely, a conspiracy theory that the U.S. government orchestrated the collapse.

1- Wang Hongying, vice president of China International Futures Research Institute.

Three factors contributed to the collapse in the gold price. The first one and the direct trigger is investors’ fear that the government of Cyprus may dump its gold reserve to deal with its debt crisis. There is a possibility that other beleaguered countries, including Italy, which has abundant gold reserves, might follow suit. This caused investors to panic.

The second factor is technical. Suppose an investor bought gold futures at US$ 1,600 an ounce, and he set his floor limit sales price at US$ 1,580 an ounce. So he would sell the futures when the market price of gold futures drops below the threshold. When this happens to a large number of investors, there would be an avalanche and gold prices would plummet. Sell-offs triggered this way would lead to gold prices being irrationally depressed.

The third reason is that there is more frothiness in the gold market than in other investment categories. The prices of other precious metals such as silver and copper have grown much less than that of gold, which increased from US$ 300 an ounce in 2002 to an all-time high of US$ 1,928 in 2011. The growth was more than seven-fold.

2- Wang Yang, fund investment analyst at Galaxy Securities

The two-session fall in the price of gold was caused by speculative investments. A large amount of sell orders placed upon the opening of the gold futures market in New York on April 12 weighed the price of the metal down to US$ 1,540 an ounce.

This is a psychologically important threshold because it is the support level of the price of gold for many futures traders. This is partly because a 20 percent decline in an asset’s price is usually considered when the market enters a bearish stage. Take the record height of gold price on September 2011 at US$ 1,923.7 an ounce as the baseline. A price 20 percent lower would be around US$ 1,540 an ounce.
Investors and analysts have come up with various reasons to explain the precipitous fall in the price of gold. In hindsight, many things could be named the culprit. They include some financial institutions’ recent reports advising investors against buying gold, weaker-than-expected industrial and economic growth in China as the largest gold-consuming country, and even a conspiracy theory that says U.S. Federal Reserve’s chairman Ben Bernanke staged the incident.

The rise and fall of gold prices depend to a large extent on how willingly people want to hold the metal. When panic sentiments set in, it appears that what drove the price through the roof suddenly does not make any sense. So investors rush to the exit, causing the price to further decline.

It is unlikely that investor confidence will recover in a short term. But in the long run, because the price of gold is inversely related to real interest rates, the opportunity cost of investing in gold will fall as the inflation-adjusted return on other types of investment such as bonds decrease. This is particularly the case with central banks around the globe pursuing quantitative easing policies to stimulate the economy.

3- Song Hongbing, author of the popular Currency Wars series of books

This is a coordinated move led by the U.S. government that is averse to expensive gold.

In the first two hours of gold futures trading on April 12, more than 400 tons of gold were put up for sale. This is almost 15 percent of global annual gold output. There is no way it is normal. The massive scale of selloff is unprecedented. So it must have been a planned and organized manipulated move.

Those reasons that are widely circulating online have all missed the point. Neither a slowdown in China’s economy nor the feared gold selloff by the government of Cyprus was enough to inflict the damage. They were played up by media to assist the launch of the attack on April 12.

As early as April 3, a message appeared online that says the United States would launch an assault on gold in April. This means the plan was leaked. Rising gold prices would impede the recovery of the U.S. economy, which depends primarily on a recovery in asset prices. This is why the United States does not like to see the price of gold rising.

*Read the original article here.