After Gold’s Dramatic Fall, What Next?

Gold recovered slightly on Tuesday after dropping to its lowest level in two years, following disappointing Chinese economic data and reports of Cyprus selling its gold reserves to recover losses.

Cash gold dropped to as low as $1,321.35 per ounce, before lifting again to trade at $1,359.51.

Prices of the precious metal have also been hit by reports that the US Federal Reserve may stop its quantitative easing (QE) programme, while India’s recent introduction of a 50 per cent import tax has been a further drag.

Rates have fallen about 20 per cent so far this year, after touching record highs of over $1,900 in 2011.

Gold, a darling of many investors over the past decade is suddenly looking vulnerable, Saxo Bank’s head of Commodity Strategy, Ole S. Hansen, said in a report on Tuesday.

Up until last Friday, gold had spent the past 18 months consolidating in a wide range between $1,525 per ounce and $1,800 per ounce.

“Speculative traders such as hedge funds, which tend to be quick on the trigger when changes are looming, began losing faith back in September: from a peak net-long futures and options position of almost 20 million ounces, they started a gradual reduction that, by last Tuesday, had seen their position dwindle to just 5.6 million ounces,” he said.

Investors who used Exchange Traded Products (ETPs) or Exchange Traded Funds (ETFs) to gain long exposure to gold continued to accumulate or maintain their position well into February. But the technical break below $1,625 per ounce called the death cross on February 20, said Hansen.

“What really rattled investors’ nerves last week was the potential for Cyprus to sell its gold reserves to cover losses. Such a sale could easily be absorbed by the market. But the worry spread that this, if implemented, could become precedent for other peripheral Euro area members’ central banks.

“Such action would have a much greater impact on gold markets considering the current holdings of countries like Spain and Italy.

“So once the $1,525 per ounce support level was reached and breached, waves of selling orders from both the spot and futures market sent the price into a tailspin. During the initial hour of carnage last Friday, almost nine million ounces of gold futures had swapped owners,” he explained.

Going ahead, the future for the metal continues to look bleak, with prices expected to drop further.

Reuters market analyst for commodities and energy technicals, Wang Tao, expects rates to fall further to $1,245 per ounce.

The downside looks pretty open down towards $1,300 per ounce, which represents a 50 per cent retracement of the rally following the Lehman Bros collapse in the autumn of 2008, according to Hansen.

“Also it is worth noting that the current price just above $1,400 per ounce is within the consolidation area between $1,300 per ounce and $1,425 per ounce, where gold spent six months from late 2010 to early 2011.

“The multi-year rally is over, but it is probably too early to make a call for a complete trend reversal,” he stated.

“The coming days and weeks will be very important as this has now become of war of nerves. Will ETP investors, especially the larger ones, be forced to continue selling? Along with hedge funds going net-short, this scenario could create further weakness. Or will the current slowing economic climate eventually trigger some support?

“The process of rebuilding investors trust will be a long one and one that has not yet begun,” he added.