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A Perceived Recovery May Be Wrecking Gold Prices

March 22, 2012 | About:

Recent declines in gold prices have wiped out more than half of their 2012 gains. Gold traders are now less bullish than they have been in two months. Many speculate that the Federal Reserve will not purchase additional debt due to the improving U.S. economy.

Following an improved economic assessment by the Fed on March 13, the price of the precious metal slid. UBS AG is just one source predicting that new quantitative easing may not come. During the week ending March 6, hedge funds cut their rally bets by the most since August 2008.

These are just some of the many things that have changed during the past month. During late February, many analysts and experts predicted that the yellow metal would continue its run. Headlines reported that record highs could be realized within days. Investors were told to purchase the metal due to impending quantitative easing. Even the warning headlines sounded positive, cautioning that prices would crash, only to rebound later in the year. When the calendar turned to March, everything changed.

On March 1, the Federal Reserve made no mention of additional quantitative easing. This dampened the bullish sentiment and caused the price of gold to fall nearly $100 during that day. Since then, headlines have been less enthusiastic regarding gold prices. They now refer to events like the fall below the 200-day moving average and ongoing corrections. Nick Moore, London-based commodity research head with the Royal Bank of Scotland Group Plc, recently stated, “A number of things which would have kept people with an eye on the upside for gold have now been neutralized.”

As Live Gold Prices recently reported:

"Gold is a highly speculative market right now. People buy it not because of income, but because of what they think is going to happen next. If suddenly people begin to believe in a recovery, that might not be great for gold. If people begin to no longer fear inflation because interest rates increase, then that certainly wouldn’t be great for gold."

Though substantial price declines create reason for any investor to become skittish, many fundamentals relevant to gold prices have not changed. The U.S. is still operating in a deficit, Iran continues to be a major concern, and the financial status of Europe remains troubled, despite the new Greek debt deal. However, some things have changed and it is these that seem to be driving the market.

According to central banks, the world is in a better place financially and financial experts and investors want to believe this. As such, they are moving their money out of the golden metal because other assets will perform better when growth returns. If demand for gold as a safe haven shrinks, other demand sources such as jewelry may not be able to carry the weight. Edel Tully with UBS recently noted that in India, gold demand responded to the drop in price, making the strongest showing since last January. However, other regions have had limited interest. Unless the demand for physical metal increases, additional downside may be experienced.

Currently, the focus is on whether the ETF market will also distance itself from the metal, said Tully. According to Dylan Grice with Societe Generale, some experts recommend selling because better opportunities exist. However, this advice is based on the fact that the global financial system is sound and the worldwide economy is improving. As noted above, unchanged fundamentals indicate that this may not be the case. Mr. Grice himself recently wrote that he owns gold because he has concerns that developed economies may not be solvent over the long-term.

The lack of commentary from the Federal Reserve regarding additional quantitative easing can be viewed as a short-term bullish signal. However, the fact remains that many Western world countries are living beyond their means. Politicians often hesitate to state this because it is not politically attractive. Experts say that until politicians bite the short-term bullet to ensure long-term gain, it may be worth holding the golden metal as insurance.

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