Sentiment in the gold market - especially among the hedge funds and institutional speculators - is already EXTREMELY NEGATIVE. Market psychology can’t get much worse. Even the gold bugs are dumbfounded. But, contrarians say this unbalanced situation could be signaling an approaching upturn in prices.
The downward pressure on prices emanates from two distinct sources of selling: First, trading by the gold dealing firms and institutional speculators in the regulated futures markets and the unregulated over-the-counter markets often guided by complex computer algorithms. These are the “dark pools” where trading goes unnoticed but the volumes of paper gold bought and sold may be huge. For more, see my May 15 post: “Dark Pools, Program Trading and the Decline of Gold.”
Second, a more recent phenomenon of great significance, has been a switch from gold (mostly in the form of gold exchange-traded funds) to equities by hedge funds and other institutional investors seeking to benefit from the raging Wall Street bull market.
With all the selling that has knocked gold to the mats over and over again in recent months - preventing price advances above $1400 from sticking - it’s just possible that there’s not much left for gold bears to dump. ?It may be that those who want to reallocate investment assets from gold to equities have already done so. ??This alone could be enough to turn the market around, if not in the next few weeks, then soon thereafter.
In truth, the recent spate of selling activity has come from in a very small number of hedge funds and institutional speculators. As noted above and thoroughly discussed in the financial press, the funds have rushed to equities, attracted by the prospect of continuing appreciation on Wall Street.
It certainly has not been a global flight from gold: Despite some softness in the past few days, physical markets remain overstretched, and bullion-bar premiums in Asian markets remain large, indicating a continuing shortage of good-delivery metal.
A small number of would-be buyers believe that patience may be a virtue. They’d rather wait than fight the hedge funds and other large-scale players who have recently made it difficult for gold to move higher.
This does NOT mean physical buyers have run out of steam — nor that they won’t eventually assert themselves — but it suggests some prospective buyers are waiting for a deeper sell-off and still more attractive acquisition prices near the lows plumbed earlier this year.
But, buyers waiting for much lower prices may be disappointed.
Meanwhile, a number of emerging economy central banks have used the last few months of price weakness to stock up. Across the board, these central banks are underweighted in gold and over-weighted in dollars, euros, yen and other depreciating paper currencies.
This week’s release of IMF data on central bank purchases showed Russia as April’s top gold buyer once again. The country’s leadership sees central bank gold accumulation as a strategic policy to diminish the U.S. dollar’s singular leadership in the global monetary system. Importantly, Russia’s gold purchases will continue regardless of market conditions.
What the IMF data did not reveal was the People’s Bank of China’s continuing purchases - probably running 10-to-20 tons per month - which, like Russia’s purchases, are geopolitically motivated and likely to continue for years to come.
Ironically, these two countries - America’s cold-war adversaries - are setting an example for private investors, particularly those underweighted in gold.
We recommend that most investors hold at least five-to-ten percent in physical gold as a long-term insurance policy against risk. Some may wish to hold more. Regardless, with equities up sharply in value and gold off considerably from its September 2011 all-time high, many investors will find they are underweighted - and in need of readjustment to bring their gold holdings back to their desired allocation.
