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The
gold price went over $1,900 and looked as though it was going to mount
$2,000, but since then has fallen back to $1,600 and is in the process of
consolidating around the lower $1,600 area. It was expected that it would
have moved a lot higher faster, but that hasn’t happened, yet.
In
the face of Italy’s downgrade
to A2 by the ratings Agency, Moody’s summary that,
“There has been a profound loss of
confidence in certain European sovereign debt markets, and Moody’s
considers that this extremely weak market sentiment will likely persist. It
is no longer a temporary problem that might be addressed through liquidity
support, and several euro-area governments are increasingly affected by the
loss of confidence.”
The
downgrading was expected as are further downgrades for the different Eurozone
members. Why shouldn’t the gold price be on its way through $2,000 to
higher levels?
The ‘Downturn’
The
news over the last few weeks has sent global financial markets down heavily
as a slow recovery morphed into a downturn and, at best, a flat economic
future in the developed world. These falls have been accompanied by
tremendous worries that there could be a major banking crisis that will
cripple the Eurozone economy as a whole, not just the debt-distressed
nations. In France, growth is now at zero; in Greece it’s somewhere
south of a 5% dip in growth, well into recession. Greater austerity simply
adds to the fall in government revenues, defeating their purpose of reducing
their deficit. All of this implies an ongoing shrinkage of the Eurozone
economy. This hurts investor capacities in all financial markets and wealth
throughout the Eurozone. Cash becomes “king” as investors flees
markets to a holding position, waiting for much cheaper prices before
re-entering markets at lower levels.
The
path to deflation is then made. Deflation in its early stages causes
tremendous de-leveraging. That’s the selling of positions to pay off
loans taken to increase positions. It may come about because of investor
prudence, banks calling in loans, stop-loss triggers and margin calls (where
the level of debt against positions becomes too high and forces sales). This
often (and particularly in the case of precious metals) has nothing to do
with the fundamentals of the market. It’s simply the position of
investors. This happened in the precious metal markets as well. This is why
gold and silver prices fell.
De-leveraging
As
was the case in 2008 and often through history, the process of de-leveraging
is a short-lived one, even when it’s savage. Downward pressure on
prices disappears once an investor has sold the positions. Leveraged
positions are the most vulnerable of investor-held positions and can make up
the froth or ‘surf’ in the markets, which cause the volatility
levels to increase when drama strikes. In 2008, these positions were huge
because there had been two and a half decades of burgeoning markets that
encouraged greater risk-taking. Since then, while leveraging has taken place,
it has been less and rapidly removed when dramas hit.
In
2008 we saw a similar drop in prices from $1,200 to $1,000 [20%], which
equates to the fall from $1,910 to $1,590 [16.9%]. In 2008, the precious
metal prices then slowly rose as buyers started to come in from all over the
world. It took over a year for prices to recover back to $1,200.
Change in Market Structure
Today
the shape of the precious metal markets is quite different and particularly
that of gold. In 2008, central banks were sellers; today they are buyers. In
2008, the Chinese gold markets were small. Since then they’ve grown to
such an extent that they’re soon to overtake India. These are two
dynamic features that give demand a totally different shape to 2008. More than
that, the impact of the developed world, long-term, has diminished quite
considerably. It now represents less than 21% of jewelry, bar, and coin
demand. The emerging world, as a whole, represents over 70% of such demand
now.
The
bulk of the world’s physical gold that comes to the market is dealt at
the London twice daily Fixings. The balance that’s traded outside the
Fixings is the most short-term price influential amounts, producing the
swings that resemble the waves on the seashore. It’s these traders and
speculators that often persuade long-term buyers to stand back and wait for
the prices to swing to the point that persuades them to enter the market. The
drop from $1,900 had this effect on investors. Now that the fall has
happened, we see a surge in demand from the emerging world to pick up the
slack in the market. We’ve no
doubt that central banks are buying the dips as well.
So
once the selling from the developed world has stopped (emerging market demand
waits for this before buying, allowing the fall to extend further) in come
the buyers happy that they’re entering the market at a good time.
Because of this change in market shape, expect the market to take far less
time to find its balance and allow demand to dominate.
2012 Recession Battle
The I.M.F. has just warned that the
developed world will enter a recession in 2012. Will that be negative for the
gold market? We don’t think so. The world has seen the recovery peter
out, the sovereign debt crisis arrive, and now sees the I.M.F. recommend that
the Eurozone banks be recapitalized. What does this mean for precious metals?
Cast
you minds back to the recapitalization of U.S. banks under the TARP measures
whereby the Fed bought the toxic
debt investments of the banks against fresh
money. When we say fresh we mean just that, newly created money in the
trillions. This did lower the perceived value of the dollar inside and
outside the U.S. The effect on gold was palpable as it rose back through
$1,200 and onto new highs.
Already
we’re hearing rumors of an E.U. government minister’s plan to
walk the same or similar road. With the recent past in mind, we’re
certain that will lower the perceived value of the euro and see euro
investors seek places to cling onto the value of the euro. This time round,
expect markets to discount these actions in the same way. The downturn will
therefore be fought with new money creation in the same way the U.S. did it
from 2008 on.
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