Gold, a heart-breaking lover

In April 2013, gold broke the heart of many. Gold lovers or what we call gold bugs, were taken by surprise. Their favorite lover had cheated on them. But who was the culprit?

Before going through the many theories out there, let’s review briefly the gold market. Gold is the only currency to have survived thousands of years. It has a limited supply, does not provide any income/cash flow and does not have any intrinsic value other than what people assign to it. It should theoretically be a hedge against inflation and a refuge against economical and political uncertainties.

With quantitative easing being used by every major central bank around the world, one might think that inflation is just around the corner. Moreover, with the Euro on the brink of collapse, it is a marvel to see gold in a bear market.

Gold demand comes mostly from jewelry & coin buyers. A small part is generated by ETF investments. Lately, these two markets were in disagreement. While the physical market saw resurgence in demand, ETF investors dumped the commodity at a very rapid rate. The reasons remain speculative.

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Like any unexpected event, the April gold crash saw many theories emerge.

The slump happened 2 days after bank of Japan’s governor announced the intensity of their QE program. Some believe investors dumped gold, a no interest asset, to enter carry trades in Yen. A carry trade is when investors borrow in Yen at low interest rates, invest in higher yielding assets in a foreign currency and hope that the Yen would have decreased in value as they pay their debt back.

We also heard of a special governmental organization whose only purpose is to kill gold or a leveraged hedge fund that exploded. Of course, no proofs were ever given to support any of these ludicrous theories.

It was probably an amalgam of reduced expected inflation, fear of a Chinese slowdown, tax on Indian Gold imports and fear of Cyprus selling its gold that exacerbated the downfall.

Despite all this turmoil in the Gold market, Gold bugs are still clinging to the fact that cancerous debt will not disappear without havoc. And havoc is Gold’s best friend. Currency devaluation should go on for a while and gold prices should pick up once the world realizes that nothing good ever comes out of debt.

As for debt, always remember what my good old Greek friend Socrates said: “The hottest love has the coldest end”.

Finally for those wanting more technical details about the 2-day April slump, here is what Credit Suisse had to say:

“On Friday 12 April the price had already begun to drift lower during the London morning session. Further selling on the open pushed gold down to test the key resistance area of $1,525 – below which traders were aware that numerous stop-loss orders rested. It took until 15:30 for the decisive break down through $1,520 to occur as Comex volumes accelerated, close to 14,000 lots (1.4 Moz / 43 tonnes) trading in five minutes. That break lower then triggered the resting stop loss orders, which created a cascade of further selling on Comex that was also mirrored by liquidation from the GLD ETF. Not surprisingly, Asian markets had to catch up on Monday, with overnight liquidation from both physical accounts and Tocom futures pushing gold below $1,450 before the London open. The surge in volatility on Friday had resulted in margin increases being imposed by major exchanges, including Comex and Shanghai, which likely contributed to the selling pressure. Further damage was done on the US equity market open at 14:30, when a large accumulation of sell-on-open orders equivalent to >300k oz hit dealers. It was only when gold got down towards $1,370 that sufficient short-covering was seen to stem the collapse. It was notable that, according to CFTC and open interest data, there was not a significant rise in speculative short positions in gold ahead of the slump in price. In our view, the number of hedge funds who were outright short gold leading in to the fall was small. That supports the view that the drop was primarily a function of OTC and ETF liquidation, coupled with intra-day position taking, rather than aggressive hedge fund shorting of the metal.”

Georges Boustany

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