Goldbugs have had a nasty week – gold has slumped to a five-year low around $1,100 an ounce. The price slid by 4.2% on Monday alone – its worst day in two years – as heavy selling on US and Chinese commodity futures exchanges saw more than $1.7bn-worth dumped on the market in a few minutes. Gold has fallen 42% from its record peak over $1,920, set in September 2011.
The sharp plunge is being put down to a bear raid, or a deliberate attack by short sellers eager to test new lows. They were “pushing on an open door”, says Alistair Osborne in The Times. They struck during Asian trading hours when Europeans and Americans were asleep. So the relatively small market was even less liquid than usual, making it vulnerable to sudden slides.
Electronic trading systems then compounded the initial sell-off because gold had fallen through a certain threshold (around $1,100) at which automatic stop-losses kick in for many traders. That triggered a cascade of selling. “This sudden drop during Asian trading seemed to have been triggered by some stop-loss sell-offs that have nothing to do with fundamentals,” says Wallace Ng of Gemsha Metals.
China disappoints the goldbugs
But while the latest plunge may have occurred partly – or largely – for technical reasons, the fundamentals are hardly encouraging in any case. Late last week China produced its first update on its gold reserves in six years. Its holdings have climbed by almost 605 tonnes to 1,658 tonnes since 2009, and now comprise 1.65% of China’s foreign-exchange holdings, up from 1.1%. This represents a significant increase, but it was nonetheless “dramatically lower than market expectations”, according to Citigroup.
Given that China has amassed vast foreign-exchange reserves, investors thought it might have spent a lot more on gold. It wants the yuan to be taken seriously as a global reserve currency and the major economies all have substantial gold holdings – notably the US, with a world-beating 8,133 tonnes. However, it may have had trouble deploying its billions of reserves into gold without driving up the price significantly, as the market is so small. But the upshot is thatChina has left the door open to further buys, “which should limit the downside for gold”, says Joni Teves of UBS.
Good news is bad news for gold
That’s for the future, however. In the medium term there are several strong headwinds for gold. One is “unusually good political news” diminishing its safe-haven appeal. The deal with Iran has reduced the risk of war and a messy Grexit has been avoided, or at least postponed. Meanwhile, fear of inflation is traditionally a reason to hold gold – but there is less demand at present, as inflation has practically disappeared. The generally poor sentiment in commodities markets has also dented gold.
The main problem for gold, however, is that “a turn in the monetary cycle may at last be on the cards”, says the FT. The US (and the UK) central banks are gradually preparing for higher interest rates. As gold pays no interest, it looks less appealing when the yield on other assets climbs.
More broadly, gradual normalisation of monetary policy reflects an improving economy, and gold prefers instability and weakness. And the impending rise in US rates is being accompanied by a stronger dollar, which also hampers gold because it is priced in dollars. A stronger greenback also makes it pricier for holders of other currencies. While we continue to suggest holding 5%-10% of your portfolio in gold as insurance, for now it looks set to go nowhere.