The violence of the fall in the gold price over the past few days has taken investors by surprise and has understandably led to questions about whether this is a short-term correction driven by technical and hedge fund-led speculative activity or if it signals the end of the 12 year gold bull market.
Below we highlight some of the factors behind the recent gold price declines and our view of the longer-term outlook.
• What are the reasons for the downward trend in the gold price since October 2012 and does it represent an end of the 12 year gold price bull market?
The gold price has been trending down since October 2012. The main reason for the fall in the gold price has been rising global growth expectations, particularly in the US, which has lifted interest rate expectations, ratcheted back quantitative easing expectations and boosted investor appetite for cyclical and risky assets. Normally this alone wouldn’t be enough to knock back the gold price, as during most risk-on moves the US dollar weakens which often helps support the gold price. However, because of the dire macro situation in Europe and aggressive quantitative easing by the Bank of Japan, during this risk-on move the US dollar has actually strengthened. This has added further impetus to the downward move in the gold price.
The gold price will face headwinds as long as US interest rate expectations continue to rise and the US dollar continues to strengthen. However, in our view these are tactical/cyclical factors that are temporary. The rise in developed economy debt burdens, driven by demographic change and entrenched interests, continues unabated. Interest rates will need to remain structurally low to offset fiscal drag, keep interest rate payments from ballooning and support growth. Quantitative easing expectations will ebb and flow with business cycle developments.
But 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.
• What triggered the very sharp sell-off in gold last Friday and Monday of this week?
There were a number of fundamental, technical and investor behavior factors that likely drove the most recent correction in the gold price. In our view it was a classic case of speculative investors taking advantage of gold-negative fundamental news and technical break-points to drive a self-fulfilling downward cascade of the gold price. Given the size of short COMEX futures positions, an equally powerful short-covering rally may also occur once markets have stabilized, new technical levels evolve and gold fundamental news improves. Below we list some of the fundamental and technical factors that may have helped catalyze the most recent frenzy of investor selling.
o The Fed FOMC minutes released on 10th April which showed some members favor an earlier exit from the quantitative easing (QE) than previously assumed.