Precious metal prices and ETFs plummeted early last week before stabilizing at new weekly lows for the year. The price declines were led by gold, with negative sentiment quickly spreading across all precious metals and some risk assets.
Gold fell 8.5%, silver (traditionally a more volatile asset) fell by 13.6% while platinum and palladium (the more cyclical of the precious metals) both fell by less than 6.0%. There were a number of reasons for the drop in the gold price. In our view it was a classic case of speculative investors taking advantage of gold-negative fundamental news and causing technical break-points to be breached, driving a self-fulfilling downward price spiral.
The short-term fundamentals on their own were only mildly negative but once prices fell below US$1,550/t oz., an important technical support level, prices plummeted down to a two-year low, triggering margin calls, momentum and model-based investor selling. Some investors saw the new price level as an attractive entry point. While some short-term tactical players have reduced their long exposure to gold (and some have actively increased short positions), physical buyers have emerged as evidenced by expanding premiums in India and China and strong demand for gold coins.
A short-covering rally before a cautious return to fundamentals? Despite a small reduction in short gold contracts (from 83,270 to 78,619 last Tuesday), the risk of a short-covering rally remains given still-elevated short positions. Indeed, the stabilisation of gold prices may be an indication of that already occurring. However, the near-term outlook for gold is likely to remain weak as investors focus on the improving US economy and its implications for less monetary easing. Even those bruised by last week’s events are likely to return their attention to the fundamentals and over the longer-term, the outlook for gold remains constructive.
The rise in developed economy debt burdens continues unabated. Interest rates will need to remain structurally low to offset fiscal drag, keep interest rate payments from ballooning and to support growth. Until the countries backing the world’s major reserve currencies put in place credible policies to control their growing debt burdens, the public will look to gold as one of the few hard currency hedges against the risk these countries continue to try to reduce their real debt burdens through the debasement of the purchasing power of their currencies. Gold will remain in a bull market until these debt issues are resolved or a credible and liquid alternative to the current fiat reserve currencies emerges.