Gold Heads South for the Short Term

There have been many factors that pushed the price of gold to about $1033/oz, and likely much higher in the long run, but consider the short-term future, where eleven billion dollars of gold sales from the IMF and potentially as much from various central banks could seriously impact the price of gold, driving it down to $800 or lower. You have to ask if governments need the money, and would they sell some gold.

(Thomson Financial Wednesday) - Gold dropped back towards $900 as investors remained wary of buying into the market due to the plan by the International Monetary Fund to sell around 400 tonnes of the precious metal. "Reports of proposed gold sales by the IMF led the precious complex to a softer finish Tuesday and have kept the metals under modest pressure so far this morning as traders carry out pockets of long liquidation," said James Moore at TheBullionDesk.com. The IMF has mooted selling as much as 403.3 tonnes of gold to bolster its sagging coffers as part of a critical financial overhaul. The proposed sale, amounting to some 12 percent of its gold reserves, could yield around $11 billion, IMF officials said, supporting a reorganization of the institution as it seeks to survive a downturn in lending to troubled countries. While the IMF's move has weighed on market sentiment, any sale still needs the approval of the U.S. Congress and many of the 185 nations that are members of the Washington-based institution. IMF officials have also said the sale would likely take place over several years in a bid to avoid unduly disturbing the gold market.

I think the issue here is two-fold: (i) government over-spending and under-taxing has caused budgetary deficits that can be partially offset by selling gold, and (ii) there is a concern, I believe, among trading nations that the $USD has fallen too far, too fast, which has caused international trade disruptions.

I anticipate severe volatility in the POG. One of my concerns is that traders who are long gold in the contracts markets (futures and ETFs) may not be left whole should the present banking system crisis worsen.

Many of you have been buying gold as a hedge against systemic credit system failure, but in fact all contracts are 'derivative' instruments created from about 98% credit. Speculators like hedge funds and wealthy individuals or even investment banks like Bear Stearns (BSC) can suddenly become insolvent, causing both the clearing agent and the exchange unable to collect margin on open positions. With the huge delay in clearing trades, something that concerns the Fed, I can envision a scenario of so many busted trades happening so quickly that profits that you think you earned are actually non-existent and prices could fall so fast that unrealized gains could immediately become losses.

Think what happens when a member of the London Bullion Market Association cannot make payment to another member. You had a glimpse of that the week that LBMA Market Maker Bear Stearns almost collapsed. The price of gold (March 17-19) dropped over 10% (about $115) in about 48 hours. So look down the LBMA members list, including Associates and Ordinary Members as well as the Market Makers, and ask yourself if all these companies would remain financially strong if one or more of the others failed to settle their trades.

This is the time to be asking questions – not after the damage has been done.

This week, I think traders are focusing on the weakening economies of the world outside the US where they know the news has been bad. But now that the other countries like Japan, the UK and in Europe are also looking weak where interest rates may have to fall, the USD is picking up strength. That move may push down on the gold price. Then the media is likely to focus more on these stories of IMF and central bank selling of bullion.

So, I continue to hold to my thesis that gold is headed south for the short term and then much higher in the long run, which will be dominated by continued budgetary deficits and credit market related problems in the US.

Comments

[JKC1967]

Good common-sense article. It does seem like some factors are stacked up tp push POG down over the next few months, but long-term devaluation of fiat currencies makes POG rise inevitable. Couple questions for the author:

1) Are you advising GLD or GDX (gold stock ETF) holders to sell now, and buy in a few months?

2) Do you, as a general rule, advise holding Gold or Silver directly, or the mining stocks? Also, any sense if the junior miners will ever pop big?

[User 30121]

I tend to agree with your assessment because having a "paper trail" to fall back on spells DISASTER in any circumstance given the lack of ownership/validity of your purchase. REMEDY: BUY and RECEIVE PHYSICAL gold and silver, period!. Otherwise your fate may be in the hands of someone who does not have your best interest at hand...to be blunt!

[User 58987]

I think you are not aware that clearing houses are the responsible to settle so if the counterparty fails then the exchange house must deliver, thats the reason they are increasing margin calls. IMF sales are discounted by the market, but in th short term gold could go down but there are many factos supporting it. I heard about a dollar rebound since 6 months ago , it wont happen al least if you take into account that us economy is headed down

[whidbey]

The proposition that gold will be volitile is supported by seasonality. As for your theme that banks can fail and may not settle trades, it is hardly news nor particularly worrying. There are some banks, but not many, in trouble. I think you are wrong on the gold instruments having no or very little metal behind them. The exchanges have assurances out that the etfs are holding metals. If you know otherwise say how. You seem to wander around your topics and never nail the facts behind them. Bad habit.