Gold has been under pressure of late to the extent that prices have dropped back to the upper ranges of last summer’s base that ran between $1,527 and $1,592. The recent low has been $1,554.65 per ounce.
The lack of upside activity in gold and booming equities have led to some rotation out of bullion into other asset classes that stand a better chance of outperforming into an economic recovery. How long that trend continues will be somewhat determined by whether investors continue to feel bullish about the outlook.
Given that the inconclusive Italian elections could stir up trouble in Europe again and the US Sequestration could dampen the outlook there, we see more room for disappointment than there may have been a few months ago.
Confidence has mainly weakened among the funds – CFTC data shows the net long fund position has dropped to 103,651 contracts, the lowest since December 2008, which is partially due to a significant pick-up in short selling. The gross short position has ballooned out to 92,219 contracts, which is the highest we have on our records.
While on the one hand this shows that the funds’ outlook is becoming more diverse, it also raises the possibility of significant short-covering if the market does not continue to head lower.
We are not surprised that some CTA-type funds have abandoned gold because they tend to be in for short-term trends. It may be that they are only out because gold has not been performing, which might not be a sign that they are bearish per se.
Conversely, ETF investors are generally holding onto their positions – the total ETF position has only dropped around four percent from its highs. In all, there does not seem to be any mass exodus by investors.
We feel the bullish arguments for holding gold are as strong as ever overall. It seems very unlikely that the US, Europe and Japan will be in a position to stop adding stimulus any time soon and, given their massive levels of debt, it could be argued that they will not want to raise interest rates – this would increase the cost of servicing the debt.
The combination of all the existing quantitative easing (QE) and the continuing budget deficits could well lead to some form of inflation, possibly stagflation.
The frightening truth is that the largest economies have amassed unimaginable levels of debt and it increasingly looks as if there is no workable solution. So far government policy has been about throwing more money at the problem – this buys time but makes the problem even bigger and, by extending the problem way out into the future, it increases the chance of another crisis.
In the case of the US deficit, the initial issue was the debt ceiling in the summer of 2011 – the solution was to kick the can down the road, which led to the fiscal cliff. That has now been partially pushed forward to the Sequester, which is now upon us.
In Europe, the austerity tied to the debt-lending is causing social unease, raising the likelihood that populist parties get into power, which in turn could scupper the recovery process.
Where will it all end? Will countries be forced to default, devalue, or inflate their way out of the debt? Given the potential for these courses of action, we feel that creditors will increasingly want to diversify away the currencies and government paper tied to this debt. All in all, we think this will lead to gold being monetarised even more while countries and investors seek to hold onto their financial wealth.
Given the large short position, if prices start to rise and shorts start to cover, their buying may well be the fuel that gold needs to get more active on the upside, in which case the trend following funds may turn more bullish again.