Short selling ahead of the August options expiry date seems to have contributed to a nearly 2% sell off in gold yesterday before the price steadied at the $1,160 level

Author: Lawrence Williams Posted: Wednesday,28 Jul 2010

LONDON - 

Belief that the economic downturn is ending and August options expiry has led to gold and other precious metals being caught in a wave of short selling, with prices slipping sharply.  The big question facing investors is does this indicate the end of the 10-year gold bull market and if so, will the other precious metals decline in its wake, or will they be supported by the presumption that their industrial usage will see demand hold up?

In truth this is probably far too early to call.  The northern summer months normally suggest a weak time for gold with holidays meaning that smaller trading volumes can have an undue influence on the overall market.  and have we really exited the economic mire yet?

If one sits down and examines the basics there certainly are still indicators of unpleasant economic news yet to come with U.S. state deficits and possible defaults potentially more than matching those seen in Greece and other European countries.  The somewhat mild European bank stress tests have muddied the waters a little, but it has to be borne in mind that the overriding interest of the politicians and government economists is to present as rosy a financial picture as possible lest the proletariat sense how dire the situation really could be and begin to panic – this being the cause, for example, of the German hyperinflation of the early 1920s as the populace lost faith in the fiscal management of the Weimar Republic, with the building panic leading to financial disaster for the middle classes in particular.

Whether governments can continue to succeed in stemming the flow of bad news, and replace it with seemingly less severe, or even positive, spin remains to be seen, but usually the bad news comes out in the end and the enormous increases in money supply seen as the answer to the local financial ills in both the U.S. and Europe has to find a counterbalance in some financial blow-off safety valve somewhere, sometime, somehow.

Looking at gold’s bull run so far there have been other major fallbacks in its path to date – yet the overall trend has always remained upwards.  Short term charts may suggest further falls, but the long term ones still look positive.  in the process of the metal’s long rise we have seen 15% and 20% fallbacks on occasion and as the metal price rises and draws in more perhaps less committed investors we could even see falls of an even greater magnitude from time to time.  at the time of writing the current fallback has only been around 8% from peak so there’s no doubt we could see a greater drop yet – or it could just bounce back on eastern buying which tends to come in, in strength, when the price falls and dry up when the price rises.

The steep fall yesterday looks as though it may have been precipitated by short selling on COMEX with a big growth in short selling ahead of August options expiry – although other observers put the drop down to the better U.S. housing figures.  But, we have pointed out here before that short selling seems to accelerate ahead of option expiry dates which some observers feel is evidence of market manipulation by the bullion banks, followed by recovery as they buy back at the lower price levels.

Over the past couple of days the initial relative strength of silver and platinum, though, had also been particularly interesting suggesting that there was beginning to be a consensus view, on rather limited information, that we are beginning to see decent western industrial recovery.  However as gold continued to fall back yesterday, silver went from holding up well to an even sharper fall, emphasising the metal’s relatively high volatility – but again, silver is even more vulnerable to heavy short selling than gold!

Looking at demand trends, the World Gold Council points to a recovery in jewellery demand in the East in particular.  Commenting on the organisation’s latest Gold Demand Trends publication, Juan Carlos Artigas, Investment Research Manager for the WGC commented  “… what cannot be overlooked during periods of heightened investment activity is that jewellery consumption over the last five years, on average, has accounted for 61% of global gold demand.  Economic development in many emerging markets, and especially China, remains a positive force for the gold market. Moreover, an appreciation of the yuan in a more flexible exchange regime will likely be beneficial to Chinese gold consumers in the long-run. furthermore, anecdotal evidence suggests that, while jewellery consumption in India and the Middle East has not been immune to higher gold prices and an increase in volatility, these markets are advancing relative to the lower consumption levels experienced in 2009.”  recently investment demand has more than made up for a fall-off in jewellery demand, and a recovery in the latter may compensate, to an extent, for a brief hiatus in the former.

But ultimately in the investment world everything depends on belief.  if the world believes that recovery is well under way then markets in general will likely rise and the flight into gold will diminish.  this is not to say that the gold price will fall back significantly – there may well be too many powerful vested interests out there which could prevent this happening.  But these interests may not necessarily be willing to drive the price up either, but will rather let it run its course as investor sentiment ebbs and flows.

The likelihood, as this observer sees it, though is that the markets and gold may move generally counter to one another relating to the flow of positive and negative economic news – and one suspects there will be plenty of both in the next few months.  There are still plenty of observers out there who believe gold will attain $1,500 an ounce this year or higher – and there are those who call for a fallback to $750.  The economic fundamentals would seem to suggest the former is still more likely than the latter, but ultimately it is investor sentiment which will prevail.  if you believe there is still bad economic news out there to come and that we’re not out of the recessionary woods yet then you may be better sticking with the precious metals – if only as insurance.  this is the position being taken so far by some of the really big investors.  if you are convinced that the recession is over and the only way is up for the economy in general, then there are probably better investments out there – but with recovery could come inflation, which could benefit precious metals again.  It’s all a matter of choice and weighing the odds.

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