Gold's Counter-Intuitive Play: Why Is Its Decline Accelerating?

London, UK - 25th September 2011, 17:05 GMT

Dear ATCA Open & Philanthropia Friends

[Please note that the views presented by individual contributors are not necessarily representative of the views of ATCA, which is neutral. ATCA conducts collective Socratic dialogue on global opportunities and threats.]

"The era of procrastination, of half-measures, of soothing and baffling expedients, of delays, is coming to its close. In its place we are entering a period of consequences."

That was Churchill in a speech to the House of Commons at the Palace of Westminster in London on November 12, 1936, as the clouds darkened over Europe. Dark clouds are hovering once again in regard to the euro, eurozone sovereign defaults and an interlinked banking crisis. More than $3.4 trillion has been erased from global equity markets last week, sending a prominent world index of shares into bear market territory, on concern that governments are running out of tools to avert another deep recession.

As the global financial crisis gathers momentum, why has gold dropped 15 percent since reaching a record $1,923.70 an ounce on September 6? Also, silver has plunged the most since October 1979. In two days, gold dropped 9.3 percent, the most since February 1983. The weekly decline of 9.6 percent was also the most in nearly three decades.

Sudden Hindenburg disaster because of engineering flaws,1937

These are the possible fundamental causes for the accelerating decline in the price of gold:

1. Exchange Traded Funds (ETFs)

The UBS rogue trader, who caused the chief executive of UBS -- Oswald Grübel -- to lose his job over the $2bn black-hole, has accidentally highlighted the problem with ETFs. As the recent ATCA briefing, "Are The $1.4 Trillion ETFs The New WMDs? Anatomy Of The Highly Toxic UBS Scandal" points out:

"Think of all the gold ETFs and then ask yourself: How much physical gold actually underpins the gold ETFs? Answer: Not a lot! As much as half of the trades in gold are now driven by ETFs, while some blame them for speculatively driving up [commodity] prices."

Top gold sources say that some ETFs are involved in fractional selling in ratios of 1:100 and there is only 1 kilo of gold for every 100 kilos of gold-equivalent ETF units which are sold and re-sold. As queries for physical gold repatriation start, gold funds and myriad financial institutions and shadow banking vehicles -- such as prominent hedge funds -- may keel over?

Attention is just beginning to gather on the accounting principles of the popular but tainted gold and silver Exchange Traded Funds (ETFs). The gold inventory is under scrutiny for usage in COMEX -- Commodity Exchange -- deliveries, enabled by questionable shorts to the GLD and SLV shares by its own custodians. The Bar Lists are regularly seen as erroneous and suspicious.

The biggest gold and silver funds are now on the defensive, as they may soon face mass investor exits on the back of heavy discounts to the precious metal spot prices and doubts about the levels of physical gold they actually hold.

2. Paying for Losses and Booking Profits

There is clear evidence that investors are selling gold to pay for massive losses in other asset classes like equities and commodities. In parallel, many investors have made a solid profit in their gold-linked investments. As the markets crash and there is a need to find ready cash and report profits, it is easier to do so by selling their hitherto profitable gold positions.

3. Source of Liquidity and Margin Calls

Gold has become the source of liquidity for global margin calls. It is difficult to say at what level this liquidation will stop. COMEX -- Commodity Exchange -- is making it more expensive for speculators to trade. CME -- Chicago Mercantile Exchange -- Group has increased the margin requirements on gold and silver. The minimum cash deposit for gold futures will rise 21 per cent to $11,475 per 100-ounce contract in the speculative Tier 1 category at the close of trading on September 26, Chicago-based CME has said. For silver, the minimum cash deposit has been raised to $24,975 from $21,600.

4. Flight to Cash

We are seeing a flight from illiquidity to liquidity, ie, from all asset classes -- including precious metals -- to cash because 2008 is still very fresh in people’s minds. In October 2008, gold prices tumbled 18 percent as the most-severe slump since the Great Depression spurred losses in global equity and commodity markets. However, the yellow metal jumped 23 percent in the next two months.

5. Too Fast Too Soon

The summer run-up in the gold price was too far too fast and too soon as institutional speculators extended their long positions in paper derivative markets. All these tell-tale signatures suggested a big fall at some stage, which has now arrived. Rather than any dramatic reversal in world physical markets, it looks like gold's precipitous price decline in recent days and weeks can be attributed at some level to the same set of speculators -- including some prominent hedge funds and the trading desks of the big Wall Street, European and Asian banks -- reversing their positions or cashing out of gold altogether.

6. Deflation and Commodities

Slowing world growth has created pressure on gold and commodities from the deflation angle. The broad slide in commodity markets also helped drag gold lower, as declines in the commodity indices prompted managers to liquidate gold.


The fall in the price of gold at a time of increased global uncertainty can be counter-intuitive for some investors to understand. Of all the reasons cited for the accelerated decline in the price of gold, knowledgeable senior executives -- with board level responsibilities in gold mining and gold bullion trading -- suspect that worries about Exchange Traded Funds (ETFs) and investors pulling out of their leveraged gold positions are amongst the most likely suspects. The increased margin requirements may still be a minor contribution but would likely cause a further modest dampening of sentiment.

Is this a short-term or long-term correction? Could the correction in gold prices be short-term and similar to initial losses suffered in 2008 or is this a more long-term correction like the one in the early 1980s that lasted for more than two decades? The length of the fall in gold prices depends perhaps on how long will it take for the ETF situation to normalise!

Some senior executives from the gold industry feel that the long-term upward trend in the price of gold is likely to continue because physical supply from new production is very limited and the overhang from central banks pretty securely locked-in for the moment. This leaves open the question that how long will the transition period of falling gold prices be before the long-term trend resumes?


We are hosting an Expert roundtable on this issue at ATCA 24/7 on Yammer.


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