Gold Panic?

The recent price action in gold can only be described as 'panic selling'. Money managers and veteran traders know that when panic sets in and markets start moving rapidly, "investing" logic drops by the wayside and money begins to flow one direction only. We have seen this over the last two trading days in long gold positions in the futures and ETF markets. This selling in turn drives prices lower, forcing those holders on margin to liquidate their positions.

This process leads to even more selling as the pain of holding levered "under water" positions becomes too great, causing traders to liquidate their positions. The light at the end of the tunnel for precious metals investors is that these events have been value-buying opportunities that occur only a few times a decade.

In the recent selloff, the gold market has been hit from all sides by news and events that have caused significant liquidation in the Comex and gold ETF markets. The first event was a report from Goldman Sachs downgrading its outlook for the gold price, sighting the precious metal's lacklustre price performance through the Cyprus crisis and a fresh batch of disappointing economic data points from the US. Last week, Goldman Sachs stated their belief that we have seen the top in gold and predicted that its value will decline to $US1200 an ounce over the next few years.

Then on Friday, Mario Draghi suggested that the sale of 400 million euros worth of Cypriot gold reserves would be used to cover any losses the European Central Bank may sustain from emergency loans to Cyprus's commercial banks. Further adding selling pressure to gold, the minutes from the last FOMC meeting, suggested there was dissention in the ranks of Fed governors concerning the future of quantitative easing in the US. George Soros, changed his opinion on gold stating that "gold was destroyed as a safe haven".

The Goldman Sachs report putting a $1200 target for gold, combined with forced selling of gold by Cyprus and questions about how long the Fed would continue monetary easing was too much for gold traders to take. Reports suggest that on Friday morning, a 124.4 tonne sell-order by a large investment bank spooked the markets and led to this decline. Intense liquidation of gold ETF's, a favourite investment theme two years ago, suddenly seemed like a trade that has 'played out'. As a result, panic set in and the gold market moved quickly to capitulation.

The gold market has seen this before. Think back to 2008. At that time we were told that there was no reason to own gold anymore, is was no longer a safe haven and that its bull run was over. Sound familiar? The main reason gold plummeted during that panic was because safe-haven buying flooded into US dollars instead of gold, driving the biggest rally the greenback has ever witnessed.

Gold subsequently bounced back from this selloff and went on to new highs. What did we learn in 2008? We learned that it was a mistake to sell gold when it was out of favour and at a low. In our opinion, the accelerated decline we have seen in the first quarter of 2013, suggests we are in a similar capitulation phase, as investors temporarily abandon their gold exposure.