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Violent And Panicky Gold Selling Collapse Bullion And Commodity Markets

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Panic on Wall Street - Image credit: Getty Images via @daylife

Panic selling in gold markets has accelerated on Monday, with the yellow metal falling more than $200 an ounce over the past two trading sessions.  The blood bath started on Friday, as sell orders for 400 metric tons worth about $20 billion hit the market, amid rumors the ECB would force Cyprus to sell gold reserves to help finance its bailout.  The violent decline was then fueled by weaker than expected economic data from China, and calls from major banks including Goldman Sachs to short bullion.  Continued ETF liquidation and margin call selling makes it difficult to see a bottom in the near-term.

“This is a self perpetuating cycle, no one wants to stand in front of a moving train,” said George Gero, precious metals expert at RBC Wealth Management and one of the many to say he hasn’t seen selling like this in four decades of experience.

Spot gold prices were down 8.7% or $130.30 to $1,371.10 an ounce by 2:11 PM in New York.  While gold had been relatively weak this year, the recent sell-off started on Friday, when they yellow metal lost more than $80 per ounce.  Experts haven’t been able to pinpoint the reason why investors have sold so aggressively, but various factors seem to have conspired to bring bullion down.

“This is what happens in commodity markets, they go up like an escalator and fall like an elevator,” Gero explained.  Selling over the past couple of trading sessions has been violent and panicky, as steep declines in the price of bullion were accompanied by the breaking of key technical levels, sparking stop-loss selling, margin calls, and then risk managers and asset allocators offloading commodity holdings to build cash levels.  The market won’t find a bottom until ETF liquidations end and Asian participants jump back in, according to Nomura.

The June 2013 contract was the most heavily traded on Monday.  Volume surged to 561,000 contracts, while open interest stood at 274,000.

One of the major psychological factors that appear to have triggered the rout was a supposed agreement between the Cypriot government and the ECB that included the sale of about $400 million in gold reserves, according to several news outlets.  While Cyprus’ gold reserves are relatively tiny (13.9 metric tons according to the World Gold Council), market participants fear the possibility that Mario Draghi and the ECB may force others like Portugal and Greece (and maybe even Italy, which has the world’s third largest gold pile) to sell, as Dennis Gartman of the eponymous newsletter explained:

If Cyprus is forced to sell gold, then Portugal shall be too, otherwise the discrimination against Cyprus shall be wholly unwarranted and utterly unfair.  And if Portugal is forced to sell, then how can Italy avoid the same fate…or Greece for that matter.

Economic data out of China helped worse the mood.  First quarter GDP numbers showed the world’s second largest economy slowed to 7.7% growth, which was well below consensus, while industrial production also weakened.

“Asian time zone price action has been neutral,” explained Nomura’s FX research team, “we note that historically the biggest sell-offs have occurred when Asian time zone price action has turned negative, such as during summer 2011.”

Gold equities are also getting hammered on Monday.  Barrick Gold is among the worst performers, down more than 23% over the past five days, while other major names like Newmont, Goldcorp, and Freeport McMoran have followed suit.

According to RBC’s Gero, part of the sell off can be explained in terms of a rotation from safe-haven assets like gold into equities.  Indeed, Nomura’s research team suggests some of the positive tail-risk hedges of gold have eased since Mario Draghi promised to do whatever it takes to preserve the euro, unveiling the OMT backstop.

Interestingly, the major fundamentals factors for gold haven’t changed all that much over the past few months.  The zero-rate environment appears to be here to stay, even in the context of increased pressure within the FOMC to taper asset purchases (or QE), while major central banks across the globe remain committed to loose monetary policy (look at Japan’s latest QE surprise).  Europe remains mired in recession, with political risk from Italy to Cyprus keeping policymakers on their feet.

The selloff in gold has spread beyond the precious metals and even to the base metals and the general commodities complex.  Last week, Goldman Sachs recommended shorting gold all the way to $1,450 an ounce, noting “conviction in holding gold is quickly waning.”  Violent selling has spread to silver, copper, crude oil, grains, and beyond.

“There are no limits, this is happening too quickly,” Gero said, “these are price decisions, not investment decisions,” he added, speaking of margin call and stop loss selling.  Algos and high frequency traders increase the speed and magnitude of the move.  “Expect the larger players to sit on the sidelines today and wait for the dust to settle as the algo systems do their thing,” Gero explained.

Gold has always been a very particular asset class.  From those afraid of hyperinflation, to those libertarians doubting the validity of fiat money, market participants have always found a way to justify their holding of the yellow metal.  That makes it all the more difficult to explain the specific dynamics of the latest moves.  Commodity markets are violent, as Gero said, and investors would do well to reassess their views of gold before deciding to jump in again.

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