Gold's volatility makes a long term focus more important

While prices have fallen significantly in recent weeks and volatility continues to rise, David Levenstein looks at what has actually changed, if anything

Author: David Levenstein
Posted:  Tuesday , 04 Oct 2011

JOHANNESBURG - 

As events are constantly changing, sometimes on an hourly basis, it is difficult to keep abreast with the latest issues.  The price of gold can change in an instant, and some of the moves can be substantial. Many of these price changes are becoming a daily occurrence. One day the price is down $50 an ounce and then before you know it, it is back up.

During this phase of volatility, it is important to keep focused on the bigger long-term picture and remind yourself why you own gold bullion. One of the main reasons we invest in precious metals, in particular gold and silver is that they are an alternative to fiat money.  If you believe as I do that the global monetary system is looking precarious and if you have doubts about the solutions suggested by our financial leaders, then it is essential to have a portion of your investment portfolio in gold and silver. Nothing has improved regarding the deteriorating state of our global monetary system, and while the current demand for US dollars is pushing the greenback higher, this cannot be sustained.

In last three weeks the US dollar has gained approximately 7% as measured by the Dollar Index, and during the same time the price of gold has dropped 16%. The reason for this sudden rise of the dollar can be attributed to a move out of global equities, commodities and certain currencies in particular the euro and into the perceived safety of the US dollar. I use the term "perceived safety" because in the long-term there is nothing safe about the US dollar.

As investors panicked when the prices of many assets plunged they simply sold everything, even assets that have medium to long-term growth opportunities. The recent selling of gold was related to panic from hedge funds needing to raise money for redemptions as well as a tightening of margin requirements. This was not selling pressure based on any fundamental change in the global gold market. And, it is important to realise that at times, price discovery has little to do with supply and demand, and has much to do with speculative trades as those transacted on the futures markets, in particular Comex.

Practically the all the trades on Comex are merely leveraged "paper" trades in gold and only a very small percent of all deals ever end in physical delivery.  And, due to the nature of leverage, the volumes can be massive but totally unrelated to the real supply and demand equation. Nevertheless, as the physical spot market and the futures market are linked to each other, the futures market can have a huge impact on the prices in the spot market. Personally, I believe that the sell-off in these futures contracts had a lot to do with the recent price fall in gold. 

When the gold price plummeted on September 23, at one time the price of spot gold was down by $122 an ounce from the daily high of $1750 an ounce. When the US session on Comex closed, spot gold was down $79/oz on the day at $1657/oz. But, what was interesting was the volumes traded on Comex. They were enormous; around 340,000 contracts...roughly equivalent to 25% of the annual production output in one session! None of these contracts will result in delivery and yet these paper trades can have a significant impact on prices. Once the speculative interest has waned and investors realise that the current global monetary crisis is not any better than it was a few weeks ago, I bet that we will see a resurgence of demand for the yellow metal.

We are experiencing the results of half a century of debt-fuelled "growth" that is becoming increasingly difficult to sustain. Banks grew so big that their collapse would have brought down the entire global economy. To prevent this, they were bailed out with huge tranches of public money, which in turn is precipitating social crises on the streets of western nations. The European Union has grown so big, and so unaccountable, that it threatens to collapse in on itself. Corporations have grown so big that they are overwhelming democracies and building a global plutocracy to serve their own interests. But now with the Eurozone debt crisis, US debt, currency wars, poor economic growth, high unemployment, the global monetary system looks increasingly precarious. While the Eurozone sets up an amicable separation from Greece, the euro remains under pressure resulting in a stronger dollar. 

Greece will run out of money to pay salaries and pensions next month unless it receives the next €8bn installment of emergency loans. European officials are scrambling to avert a Greek debt default, which could wreck balance sheets of European banks, send the euro lower and possibly plunge the world into a new global financial crisis.

Then today, Monday October 03, 2011 the Greek government said it won't meet its deficit target this year and agreed to additional austerity measures demanded by international lenders ahead of a meeting of Eurozone finance ministers. Greece's 2011 deficit is now expected to be 8.5% of gross domestic product, falling short of a target of 7.6%. The deficit will be reduced to 6.8% of GDP in 2012, but still short of the 6.5% target.

The Greek finance ministry said the targets will be missed because the nation is suffering a much deeper-than-projected recession. The economy is now expected to contract 5.5% in 2011 compared to the 3.8% contraction projected in June. The news increases the possibility of a delay of the next tranche of bailout funds. It also spooked investors who rushed to sell shares Monday in Asia and Europe.

Frankly, we all know that the situation in Greece is dire and that they have no hope to pay back any of these loans. I believe that despite the political rhetoric of government leaders, the leaders of the Eurozone are setting up for an "orderly" default by Greece due to the impossibility of Greece being able to service an ever expanding debt mountain. While their package will protect the banks from collapsing, it will also necessitate the monetization of the debts of the PIIGS meaning very simply printing more money.  As the value of the euro declines, individuals will look to preserve their savings and turn to gold.

 

TECHNICAL ANALYSIS

 

Gold prices are beginning to consolidate above $1600 level after the recent drop. I believe that this period of consolidation will not take more than a few weeks.

Source: http://www.mineweb.com/mineweb/view/mineweb/en/page103855?oid=136820&sn=Detail&pid=102055