Putting The Current Gold Price Correction Into Proper Perspective

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Includes: GLD
by: Tim Iacono

Following another sharp sell-off early in the week, amid signs of strong physical demand in Asia and the U.S. at recently lower prices, gold and silver bullion both posted their first gains in five weeks, starting to make back some of the ground that was lost during a miserable September, during which time the price of gold tumbled 14 percent and silver plunged 31 percent.

For the week, gold rose 0.9 percent on the spot market, from $1,624.80 an ounce to $1,638.70, and silver jumped 4.3 percent, from $29.97 an ounce to $31.27. The gold price is now down 14.8 percent from its summer high but maintains an impressive gain of 15.3 percent for the year; silver is down 36.8 percent from its spring peak, now up 1.2 percent in 2011.

Anecdotal accounts continue to be heard about hedge funds being forced to liquidate their winning gold positions last month in order to cover losses on their stock holdings and of big premiums being paid in Asia due to supply bottlenecks as dealers continue to have difficulty locating enough physical metal to meet demand at current prices.

As was the case back in late-2008, it is now commonly believed that the need for liquidity by futures markets traders was the primary reason for the recent sell-off. Now that the gold price has dropped from above $1,900 an ounce to below $1,600 an ounce before staging a modest rebound over the last week or so, strong physical demand from Asia and elsewhere has put a floor under prices at about the $1,600 level, with the gold price ultimately going higher.

Since we are now more than a month into the current correction, it seemed like a good idea to see how this one stacks up against others that we've seen over the last ten years. The result is the graphic below (click to enlarge image).

It should be clear that, based on the 2006 and 2008 corrections, we could have much further to go; but, if the only example of a post-2008 correction occurring in late-2009 is followed, then this correction may have already seen its lowest lows.

Looking closer at the 2009 correction reveals that it wasn't much of a correction at all, taking just 45 days to retrace 12.7 percent from the December high to the February low.

The absence of significant price declines since the 2008 sell-off - a stretch of almost three years without a "typical" correction of 15 or 20 percent - has been a defining characteristic of the post-financial crisis gold market. It remains to be seen whether short shallow corrections will be the new norm.

Based on the data presented in the chart that uses the closing price of the SPDR Gold Shares ETF (NYSE:GLD), the current correction reached a 15.7 percent decline on Thursday, September 28th - just 26 trading days after the rout began. Those bearish on the yellow metal will be heartened to learn that if the 2006 or 2008 corrections are to be equaled, we won't see a final bottom for three to six months with anywhere from another 5 to 25 percentage points decline in price.

My guess is that the current correction will be more like that seen in 2009 rather than the more severe, prolonged moves down in either 2006 or 2008. Importantly, for those expecting a hasty return to the $1,900+ level, even though the 2009 correction was shallow, it took a full six months before the old price peak was again achieved.

Analysts also see higher gold prices in the year ahead. Last week, Goldman Sachs cited low real interest rates in the U.S. as a reason for raising their gold price forecast this year and holding firm on their 12-month outlook for a gold price of $1,860 an ounce. A Bloomberg analyst's forecast for the gold price in 2012 rose from $1,406 in June to $1,781 last week and Credit Suisse raised their price target by 19 percent to $1,850 on Tuesday, while both BofA Merrill Lynch and Barclays held firm with their one-year calls for $2,000 gold and Morgan Stanley raised its forecast for next year some 35 percent to $2,200 an ounce.

Investment banks surely haven't been scared off by the recent correction - neither should anyone else.

Disclosure: I am long GLD.