Gold Drops, But For How Long?

Friday, 23 Sep 2011 03:32 PM

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Gold prices have shot up in the last two years on time-tested belief that when currencies weaken and uncertainty rules the day, the yellow metal serves as a safe haven.

Global markets, as well as economies in general, remain anything but certain, and stock markets have tumbled on debt woes in Europe and how they may bruise financial sectors worldwide.

Yet investors are now ditching gold as well. The most-active December gold contract on the Comex division of the New York Mercantile Exchange ended the day at $1,639.80 an ounce, down 9.6 percent for the full week.

The giant ETF SPDR Gold Trust (GLD) stood at $159.80 at the market bell today, down from a close of $169.05 on Thursday.

Hedge funds are fueling the sell-off, getting out after an 18-month rally, traders tell the New York Times.

One reason may be that hedge funds need cash to meet increased capital demands from Wall Street banks who lend them money.

In the past, hedge funds could put up assets like commodities or stocks as collateral, but the values of those resources have tumbled this year.

Plus, the latest Federal Reserve move to shuffle its Treasury portfolio to drive down long-term interest rates is sparking global demand for U.S. debt, and dollars are needed to buy that debt.

Demand for dollars often goes hand in hand with a need to ditch gold.

“On the one hand you have a lot of strength in the U.S. dollar; historically gold and the dollar do trade inversely,” Ryan Detrick, senior technical strategist at Schaeffer’s Investment Research, tells the New York Times.

“The hedge funds are long gold and they need to raise cash and it looks like they are definitely selling some gold.”

Some hedge funds may be selling to meet redemption requests from investors who have been spooked by the recent market volatility and fear a repeat of the problems of late 2008.

So they tell hedge funds they want their money back and the funds go out and sell.

“A lot of investors are waking up to the realization that something is off. We’ve seen Goldman Sachs close its flagship fund, legendary hedge funds are down sharply, and I suspect we’re going to see significant withdrawals from some hedge funds this year,” Michael A. Gayed, the chief investment strategist of the investment advisory firm Pension Partners, tells the New York Times.

“The tendency for individual hedge funds or anybody is to sell winners before they sell losers. What’s been one of the few winners this year? It’s been gold.”

Others say the demand just isn't there anymore to support higher gold prices.

On Aug. 2, holding by large gold speculators — namely hedge funds — hit "readings that are the highest ever in our records," according to a Bank of America Merrill Lynch analysis, CNBC reports.

The $40.6 billion notional value of gold contracts held by speculators was up from $38.1 billion just a week earlier, according to Merrill Lynch analysis.

Should big names say they're turning away from gold, like billionaire financier George Soros did earlier this year, expect more selling to occur.

“Truth is no one else knows where else to put their money, but as soon as a Soros-like figure exits his massive gold position, there will be a huge panic sell-off,” a trader tells CNBC.

“Just in terms of simple mean reversion, it looks like we could easily snap back to the $1,550-$1,600 level at the blink of an eye.”

While certainly not a universal opinion, others agree that gold can't remain a safe haven forever.

"At this point in time, I don't think one can say that the safe-haven rationale for gold is off. It's just that it has been going up so much that we needed a very deep correction," says Afshin Nabavi, head of trading at MKS Finance, according to Reuters.

© 2014 Moneynews. All rights reserved.

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