Gold Prices Hold Steady after Last Weeks’s Bear Raid

Since around mid-June, gold prices have come under substantial selling pressure. One of the main drivers behind this fall has been the on-going debate about interest rates.

While the general narrative supposes that higher interest rates will have a negative impact on gold, I have often stated that this assumption is not correct. The historical record shows that gold tends to rise with nominal interest rate rises – as was seen from 2004 to 2008 and in the 1970s – and the Fed is unlikely to raise rates in any meaningful way while deflationary forces persist.

According to the WGC, although higher interest rates would make the dollar more attractive to investors looking for higher-yielding assets, the current narrative that this scenario would be bearish for gold is incorrect.

It is true that higher real interest rates raise the opportunity cost for investors holding gold. But our analysis of the gold price and previous rate conditions found gold may perform reasonably well in a positive rate environment. Our analysis indicates that gold is only negatively affected when real rates nudge higher than 4%. The current outlook suggests the US rate increases will be moderate and real rates will be below 4% for some time.

 In addition, markets are forward-looking and the forthcoming rate rise has been well flagged. It would be surprising if expectations of US rate rise were not already factored into the gold price.

Gold prices plummeted to five-year lows last Monday due to bear raid conducted by some mystery seller.

While many market commentators believed that Monday’s decline in gold began during Asian trading, in actual fact the first wave of selling took place when  the equivalent of 24 tons of gold were dumped onto the Globex electronic trading exchange in New York in less than 2 minutes. Data revealed that the volume traded in one minute was 7,164 contracts, which at 100 ounces a contract is about 22 tons.

The selling began on the COMEX in the August futures contract on the CME Group's Comex futures in New York a tenth of a second after 9:29 a.m. in Shanghai.  Japanese markets were closed ensuring a minimal amount of liquidity and potential buyers to support the price. Then, an additional 33 tons of paper contracts flooded the Shanghai Gold Exchange.

While there appears to be some discrepancy in the figures reported by different analysts and media, the selling knocked the price almost $20 to $1,100 per ounce during those four seconds. It marked the first leg of a dramatic 60-second sell-off that saw prices sink more than 4% to five-year lows.

One thing that I am sure about is that the price action didn’t appear to be driven by fundamentals. The nature and timing of the selling suggests that this was not traders responding to a slight strengthening in the US dollar, but was a very well-orchestrated bear raid. Whoever did the selling, the party concerned chose the time when the market had minimum thus being able to slice through the bids in a clear attempt to smash prices and confidence in gold.

In the immediate aftermath of gold’s massive price slam, media was quick to attribute the selling to Chinese traders.

But the most well-known Chinese funds denied involvement, and as futures trading is anonymous, dealers may never know who was buying and selling during those crucial seconds.

In a report issued by the World Gold Council (WGC) the organisation stated.  On Monday 20th July 2015, the gold price fell sharply during Asian trading hours. The price declined from a closing price of US$1,134.14/oz. on Friday, to an intra-day low of US$1,086.18/oz., a 4.3% fall. It quickly rebounded to stabilise a little above US$1,100/oz. This fall was precipitated by significant trades on the Globex platform on COMEX and the Shanghai Gold Exchange (SGE). Trading data reveals that 4.7 tonnes (t) was off-loaded on the SGE at 2.29am BST – this is an exceptionally large amount in a short space of time. Normally little more than 40t trades in a day. At around the same time volumes spiked on COMEX. Both trades were made during periods of low market liquidity. Sell orders in China and US triggered the price fall.

The price has seen further, less dramatic, declines since Monday. With trading volumes thin, and market sentiment for gold at low levels, the price has now fallen below the US$1,100/oz. level. This is the lowest price level since Q1 2010.

The recent price fall, in common with similar price action in the past few years, was triggered by isolated trades. These trades are not representative of the broader supply and demand dynamics. In thin trading conditions, these actions have a significant impact beyond the relative scale/volume of any corresponding net flows; they are often reflective of and can amplify capital market sentiment in the west. But although these traders provide a depth of liquidity in the market, they are not the key buyers of gold. They do not shape demand over the longer term. These types of large gold trades have been a characteristic of COMEX in the past, but they are less typical on the SGE, where trading volumes are lower, albeit increasing quickly. There has been some speculation as to who made the trade on the SGE. The Financial Times drew parallels with similar trades in other metals in China recently, such as nickel and copper.  Nevertheless, short-term speculative transactions, divorced from physical delivery and amplified by leverage, are likely to remain centred on COMEX, rather than on exchanges that have been developed to facilitate wider access to physical gold, such as the SGE.

In the end it seems as if the real culprit was a US-based entity masquerading as a Chinese trader.

Prices have recovered somewhat but have failed to break back above the $1100/oz. level.  

Even though the gold price has dropped below $1,100 per ounce, it is important to note that in many other currencies gold has fared relatively well. In euros, it is now around 1,000 euros per ounce which is still slightly higher than it was a year ago.

If you are a European living in Europe and saving in euros, you would have been better off investing in gold one year ago than keeping your money in the bank. And with interest rates near zero and even negative at times in parts of Europe, your euros would not have made any interest of any significance.

This current negativity is unwarranted given the reasonable performance of gold this year in currencies other than the dollar. Even following the smash gold is up 4.4% in euros this year. It is also up in Australian and Canadian dollars – not to mention in Latin American currencies which are again under pressure.

During the last twelve months, gold in Japanese yen, it is slightly higher than a year ago. It is up by 8.43% in Australian dollars, up by 26% in Brazilian reals, up 1.46% in Canadian dollars, up 5.66% in Mexican pesos, up a whopping 39.8% in Russian rubles and up by 1% in South African Rand. 

At the same time, it is down by 10% in Indian rupees, down 8% in sterling, down 15.71% in Chinese Yuan and down by 10.56% in Swiss Francs.

Physical gold will protect your wealth in the event of a banking crisis, or a financial collapse which I believe is imminent.

And, the big news to hit the global gold market was the announcement about Chinese gold reserves.

China shocked the bullion market by declaring its official gold holdings for the first time in 6 years.

In a statement from the People’s Bank of China (PBoC), China boosted bullion assets to 53.31 million troy ounces, or about 1,658 metric tons. China last reported a figure of 1054 tons in April 2009.

With only 1658 tons of gold reserves this would put China in 5th position behind the US (8133 tons), Germany (3383 tons), Italy (2451 tons) and France (2435 tons). But, it is my belief that the US doesn’t hold anywhere as much as stated. In fact, I would be surprised if it actually holds a tenth of what they claim.

Frankly, I would be very surprised if the Chinese don’t have significantly more gold than these latest claims. Many gold analysts were expecting a much higher figure. Gold remains a large part of many central banks’ reserves, decades after they stopped using it to back paper money. Stockpiles of the metal help China to diversify its foreign-exchange holdings as the world’s second-largest economy seeks to raise the international profile of its own currency. The disclosure on gold reserves also assists in that goal.

The IMF will be considering the inclusion of the yuan under the special drawing rights in October. However, evidently the PBOC has more legwork to do if they want to be taken seriously. That could mean China may issue another update on its holdings around October.

The disconnect between the so-called “paper gold” market — dominated by options, futures, and unallocated ETFs — and the physical gold market continues to manifest itself.

Even as the price of gold denominated in U.S. has fallen, major mints around the world were reporting robust sales.

Strong sales figures reported from two of the world’s major mints – U.S Mint and Perth Mint - show that the importance of physical precious metals to weather major financial crises has not been forgotten despite the underperformance of the price in U.S. dollars. 

Investors should not be deterred by this latest price plunge and take advantage of the current low bullion prices to accumulate more physical gold.

While, I think the current negative sentiment towards gold is unjustified, and set to continue  as far as I am concerned, the investment case for gold remains intact. The long-term investment case for gold is not based on short-term price movements. I believe every investor should own some physical gold and have it stored out of the banking system. And, if you have not yet included gold in your portfolio this is probably a great time to buy. It may go down lower, but you will almost never find the bottom.

TECHNICAL ANALYSIS

The price of gold has breached several support levels, but seems to be holding above the level of $1080/oz. It is also oversold at current levels, so I expect a small rebound in the short-term.