One thing has been consistent with the selloff in gold. There’s always a really good story to explain why the market reacted the way it did. The initial move was the selloff triggered by the Bank of Cyprus announcing the potential sale of a portion of their gold holdings in order to relieve some of the stress of their failing financial institutions. The thought that gold would be an asset to relieve not just troubled Cyprus, but potentially all the struggling European nations started to spread.
The second move down was attributed to downward pressure from massive institutional sales and breaking the key technical support level of 1,550 US/oz. Outflows from gold backed ETF’s began to see record levels as the masses headed for the exits. In accordance with this, the fears began to surface that tapering of the Fed’s asset purchases would soon begin.
This most recent selloff, and again linked to the Fed and the explicit language chosen by Chairman Bernanke was that the US economy is healing, and aggressive monetary support should no longer be needed should the trend continue. If we incorporate this with a staggering economy in China and the stress their banks are under as a result of tremors in the Shibor market (the interbank lending market for their banks) the pressure on gold seems insurmountable.
Gold’s run, however, began long before talk of Quantitative Easing. It was the move into real assets in the beginning of this century as interest rates continued to move lower and lower. So as stimulus provided in the form of Quantitative Easing was a great catalyst for gold, it has really been this epoch of falling interest rates that has been supportive of this market. Initially the “Greenspan Put” and what has become the “Bernanke Put” was gold’s best friend. Unfortunately though, the potential collateral damage done to the economy through central bank induced asset bubbles is yet to be realized.
Some analysts use the term “stable disequilibrium,” and I truly believe that is the economic environment we are in today. The workings of western central banks’ and the asset bubbles that they have not only created, but sustained is what has prompted this extreme volatility in financial markets. The best story for gold stems beyond the idea of an inflation hedge, or for that matter a store of value. Gold is the hedge against economic uncertainty. Plain and simple, it is valued for its role in history; it is not valued because of some revelation of its existence in the last ten years.
The problem with gold is that it has become victim to the herd mentality that creates this volatility and price instability in financial markets. Since becoming more and more accessible via exchange traded funds and more and more popular for speculators in the futures market, it became vulnerable to the same instability that is prevalent in all markets today. It is not so much that the belief in gold has ended, yet the current trend, or fad if you will, is coming to an end.
This herd mentality was present in the physical market as well. It was seen when silver was moving past 40 dollars an ounce, and without much thought physical positions were being accumulated by novice investors who were looking to make a quick profit. If only it was that easy. Gold isn’t a get rich quick scheme and it never has been. In the long term it has the potential to be a store of value. To not be too cliché, “an ounce of gold buy’s a decent man’s suit.”
The above should not been taken as a defence against the selloff in the gold market, or a bleak diatribe on the world’s financial markets. It’s just meant to be plain and simple. Gold is a hedge against uncertainty. It is a long term play. Like any asset, it contains risks. There are buying opportunities, and there are times to sell. Over the next several months to two years, it is my opinion that there will be good opportunities to make long term play in the gold market.