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Gold: Further Downside To Price In Offing

 February 25, 2013 01:23 AM


(By Mani) After pushing close to $1,800/oz. in October 2012, gold started a rather rapid slide to barely above $1,570/oz. Although that is a problem, the real issue is that $1,800/oz gold was already much lower than the level of just under $1,900/oz. reached in September 2011.

The real cause of concern is that gold is now testing the boundaries of the longer-term bull channel that started in 2001, but really accelerated around 2005.

Against a "stalling" gold price, the outlook for economic growth seems to have returned – particularly in the U.S. and to a slightly lesser degree in China with only the Euro zone still seen as stuck in the hole.

So here's the "deal" – macro and large hedge funds have had a field day on these broad themes since the start of the year, going long equities in Japan, Europe and the U.S. along with junk bonds and crude and going short the usual "safe havens" such as gold, the yen, treasury bonds and German bunds.

[Related -Gold: The Ultimate Store of Value?]

"Behind this lies the fuel that fans this fire – global central banks providing non- stop liquidity. This provision is so "guaranteed" that central banks are now effectively setting the risk taking parameters for investors," CIBC analyst Barry Cooper wrote in a note to clients.

In other words, an unwavering "faith" in the Fed and the European Central Bank to be there pumping more easy money into the system constantly creates a certain "tilt" in the markets that ignores the fact that a lot of this action flatters financial assets, but does very little to the real economy.

There comes a point though where the free lunch ends and the real economy must stand on its own merit. At the moment, the free lunch continues to win the day as money continues to pour into new speculative bubbles.

[Related -Why Gold Is Undervalued]

"If this carries on a bit longer, it is not beyond possible that the gold price drops even further. The unfortunate thing about this is that the gold price is very often traded on technicals and once through the bottom of this channel, could fall sharper and faster," Cooper noted.

There is an argument that recent dramatic swings in physical buying patterns with central banks becoming major buyers rather than sellers could well see a deficit market in gold if it were to continue. But, even these shifts in the buying pattern only reflect the change in the underlying real interest rate environment, when it turns positive, the same central banks will turn big-time sellers.

That's not to say that gold will necessarily plunge from here, only that the real support is not expected to be there while the central bank induced market conditions exist. These may change at any time of course.

Momentum plays have a tendency to run out of that very momentum at some point, but investors have to acknowledge the real risk of further short-term downside to the gold price.

"At some point, the super low rates and currency devaluation will reignite the inflation flame, but until then, the current trend is not gold's friend," Cooper added.

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