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Potential reasons for the recent decrease of the gold price

April 16, 2013

The price of gold fell from U.S. dollars 1,575 on April 10th more than 11% to U.S. dollars 1,395 on Tuesday, April 16th. Intraday the gold price had even fallen to as low as about U.S. dollars 1,322 per ounce.

On Tuesday, April 16th, the gold price started to recover a little bit and has currently increased to the U.S. dollars 1,3750 level. Investors are anxious, whether the abrupt decline of the gold price was just a – although quite hefty – correction or if they have to expect a further slide over the coming days and weeks.

Potential causes for the fall of the gold price

Various analysts and amateurs are currently coming up with their theories of what caused the drop. Below we state and analyze different potential causes for the fall of the gold price.

1. Market correction

The price of gold has increased for each of the last 10 years up to 2013, in total by more than 450%. Various analysts expected a correction of the gold price for quite some time. The overall extent of the current decrease is not unusual compared to the decline during previous corrections of the gold price. Although the speed of the correction was unsual with a drop by more than 15% (intraday) within just three trading days.

2. Cyprus gold sales

On Thursday, April 11, it was reported that the central Bank of Cyprus could eventually sell gold reserves in order to reduce debts. Many sources cited this as a cause for the drop of the gold price. But in February 2013, the value of Cyprus’ gold reserves stood only at about 550 million Euros. So the overall amount should – even if sold – not really put a strong pressure on the gold price. On the other hand, a potential sale could possibly act as a blueprint for debt reduction by other indebted countries like Portugal or Spain.

Another explanation would be that just the risk of a potential sale acted as the starting point for a chain reaction amongst investors, who became anxious, started to sell gold etc.

3. Less monetary easing

Ironically, while many gold bugs demand to reduce government spending and stop monetary easing, the growing chances that monetary easing could be reduced or stopped not too far in the future could now impact the gold price negatively. The reason is that monetary easing has created a lot of liquidity which poured into various asset classes including gold. A reversal could imply that money flows out of different asset classes including gold, i.e. that gold is sold by investors.

A stop of monetary easing could also mean that the risks for inflation in the future are possibly lower. Fear of inflation is a key buying argument for some gold investors.

4. Economic recovery

The key reason for the expectation that monetary easing could be ending in the U.S. is an economic recovery. In addition to the argument of less monetary easing, economic growth in the Western countries often leads to rising stock prices and less interest in gold as an asset class.

Interestingly, while gold demand in the Western countries is heavily driven by investment demand, which tends to be stronger in times of severe economic problems or crises, in Asian countries like China gold consumption is strongly positively correlated to economic growth. The better the economic development in countries like China, the higher is their demand for gold.

5. China

This brings us to the next often cited argument for the gold price decrease: Recent growth statistics for China were below expectations. As explained above, a slowing growth in China could lead to less demand for gold from China. Over the last years, China developed in a key consumer of global gold supply.

6. Gold import tax rates in India

India is the other key gold buyer in Asia besides China. The commodities guru Jim Rogers sees the 50% increase of the Indian import tax rate on gold at the beginning of this year as a potential cause for the weakness of the gold price.

7. Bitcoin

Jim Rogers also cites the recent collapse of the price of bitcoins – the alternative digial currency that increased significantly in value over the last years, but especially in the first months of 2013 – as a potential driver for the fall of the gold price. He argues that most of the investors who hold bitcoins would be also invested in gold – and therefore probably sell gold holdings after the fall of the value of their bitcoins.

8. Japan

The precious metals refiner Heraeus sees the monetary policy of Japan as a potential reason for the recent gold price decline. The Bank of Japan has announced measures to weaken the Yen. This drove the gold price measured in Japanese Yen to the highest level over the last 33 years. Heraeus says that a lot of private gold owners would therefore currently sell gold, which would drive down the gold price. Interestingly, with its huge debts and the new monetary policies, inflation risks should rise in Japan – in the longer-term this could potentially make gold a good investment especially for Japanese investors.

9. Technical or behavioural factors

Adrian Ash of the vaulted gold provider BullionVault writes that gold’s recent price chart looks horrible. When the gold price started to fall, it broke through several support levels.

This development could have started a ‘self-reinforcing cycle’, e.g. automated trading algorithms could have automatically started selling further positions in order to minimize losses and so on.

10. Hedge funds

While many private investors have a long-term view on their gold holdings, over the last years also a lot of speculative investors built gold positions. This was facilitated by new products like the gold ETFs, which are often bought by instutional investors, e.g. hedge funds. Those investors are acting very quickly and the negative development of the gold price has definitely led to sales by many institutional investors – which in turn strengthened the gold price slide.

11. Manipulation

There are some people, who believe market manipulation being reponsible for the decreasing gold price. A large share of the professionally traded gold positions is not traded physically but through contracts like futures. While these instruments can probably speed up a price movement, we do not believe that they are really effectively used to ‘manipulate’ the gold price.

But the shorter reaction times resulting from those new instruments could – comparable to high-frequency trading in the stock markets – accelerate and intensify price developments. This effect, coupled with technical or behavioural effects described above, could have made the gold market more vulnerable to fluctuations.

Given that large holdings of physical gold – in the hands of consumers, private investors or companies like jewellers – are at least in the short-term more or less “off the market”, the behaviours of large institutional investors can have significant short-term impacts on prices.

Conclusion and outlook

It is currently to early for a final conclusion of what the key drivers of the recent fall of the gold price were. As described, there are many different influencing factors – potentially it will never be possible to find the real causes for the price decline.

Over the coming days and weeks we will see, if the recent development was just a price correction or whether the gold cycle turned and we will see a longer bear market.

As often stated by us, private investors should be very careful, if they intend to speculate with gold. We see gold more as a kind of portfolio insurance that can help to diversify your assets and protect the value of your portfolio against big fluctuations or financial or other crises. But this implies that you should only invest a share of your assets in gold – as it applies to other asset classes.


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