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Gold Losing Its Sheen On Fed QE Tapering Fears And Chinese Credit Crunch

Jul. 01, 2013 10:49 AM ET
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Commodities Weekly Analysis - Gold

FXStocksData | June 30, 2013

Gold Prices Tumbled by 25%

Gold has tumbled last week by a further 5.3% closing at $1223.70 an ounce on the Comex division of the New York Mercantile exchange. The slide began in April 2013 when the investors started worrying over the rumors on Fed tapering fears and led to a sharp decline after Bernanke confirmed that Fed may scale back the stimulus soon. Gold is down by 25% on the quarter and annual losses reach up to 27%, the biggest annual drop since 1981.

Cheap money and QE Tapering Fears

Ever since QE3 was announced in September last year, when Fed started purchasing assets worth $85 billion every month, gold prices have rocketed as investors started buying it as a safe haven against the weakening US dollar and hedge against a possible inflation.

Fed chairman Ben Bernanke hinted during last week's FOMC policy meeting press conference on scaling back the $85 billion monthly asset purchase program later this year suggesting that the Fed believes the economy has grown considerably since the inception of the stimulus program and the time is nearing to scale it back. Bernanke added that Fed would start unwinding the stimulus slowly later this year and by mid 2014 it expects the program to come to an end. The confidence investors had with the Fed over the past many months has been shattered overnight and commodities especially gold has been the worst to react by sharp falls.

And Chinese credit crunch added to more worries

Before the investors could digest the Fed's statements the People's Bank of China on Monday suggested it would not step in and inject money to prevent a rise in the inter bank borrowing rates. The rates which banks borrow from each other in China have jumped sharply between 10% to 25% from a mere 3% a month ago, which raised concern about the impact it would make on the non-bank lenders. Nevertheless, the Chinese central bank assured that it would "contain financial risks with more solid actions" and "fine-tune policy when necessary." The tight money in China coupled with the announcement of gold import restrictions by India have prevented the buyers to step in aggressively.

Investors remain cautious and so do the miners and so do the central banks around the world

Major investment banks from Morgan Stanley to Goldman Sachs have cut their gold forecasts. According to these investment banks much of the current selling is coming from long-term investors who would have in any other scenario happily ignored the volatility in the precious metal's value. There is a considerable liquidation of the bullion occurring to cover margin calls and also to square off the end of the first half of 2013.

Economists believe the gold miners would struggle in the months to come and may need to revise down their valuations with most of them already under pressure to remain in business.

Central banks' gold reserves, according to a study by Banc De Binary, have been hit by $429 billion of theoretical losses due to the recent sell off. There remains a big concern whether they too will act on gold's tumbling prices and unwind their reserves. If they do that it will have lasting effects on the 'safe haven' status of the precious metal in the months to come. On the other hand the central banks could opt to seize the opportunity and increase their gold reserves, but thanks to the lower account balances in the emerging world, such an option remains highly unlikely.

Buying Opportunity or Sell further - The US GDP factor and Fiscal concerns

Investors remain muted on the plunging prices of gold and expect to see the prices stabilize before buying in. Over the past few weeks speculators selling the precious metal have far outweighed the buyers. Gold will undoubtedly remain under pressure and volatile in the short- term and for it to rebound the Fed should restore confidence by talking down the tapering fears which has rattled the markets. The economic data coming in from US has been mixed with US housing and consumer confidence at a five year high, and house prices jumping to a seven year high reinforcing Fed's statement that economic conditions have started improving and the scale back of the Fed's fiscal stimulus is imminent. The glimmer of hope being the worst first quarter US GDP figures which has been revised to 1.8% from the original 2.4%. Investors may take heart from that and would hope that the Fed cannot scale back the stimulus anytime soon until the GDP improves considerably.

Irrespective of Fed's decision gold remains a best bet against the backdrop of fiscal concerns, inflation and political uncertainty which may encourage investors to go on the bargain hunt and any further statements from Fed alleviating the tapering fears will see the gold prices stabilize and a sharp rebound may be inevitable.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

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