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Explaining gold price fluctuations

Steve Saville
Apr 20, 2010

Below is an excerpt from a commentary originally posted at www.speculative-investor.com on 18th April, 2010.

Most mainstream financial journalists try to link the daily market action with the news of the day, as if the markets did nothing other than react to news. In general terms, they make the assumption that if a market fluctuation coincided with or followed a news event, then the news event must have caused the market fluctuation. Due to this modus operandi, it is not uncommon for journalists to cite the same event when attempting to explain a price rise one day and a price decline the next. For example, if the stock market rises one day and then falls the next, and at the same time there is news of a Greece bailout, it would be typical for the press to link both the rise and the fall to the bailout news.

The linkages between news events and market action that are concocted by journalists are usually banal and uninteresting, but occasionally they are so ridiculous that they are laugh-out-loud funny. An example of the laugh-out-loud funny variety is the explanation for last Friday's decline in the gold price in the article linked HERE. We started chuckling as soon as we read the opening line:

"Gold prices Friday were dropping steeply as investors traded out of riskier assets like gold and into the U.S. dollar."

We read on with great anticipation, and weren't disappointed. The following sentence from the third paragraph had us is stitches:

"The news that the SEC charged Goldman Sachs with fraud was killing gold prices as investors rotated out of riskier commodities and into safer assets like the U.S. dollar."

We thought it couldn't get any better than that, but in the very next sentence the article's author displays another piece of comedic genius when he says:

"The gold price had been finding support around $1,150 an ounce after better-than-expected earnings from big U.S. companies."

So, let's get this straight. Gold, the ultimate "safe haven" over thousands of years, had been boosted by good US corporate earnings news, but was then dumped in favour of the dollar (a liability of the US banking system) in response to news that the US's most important financial institution could be in trouble with the regulators.

Those who fixate on manipulation regularly cite articles such as the one linked above to support their case, but like much of what passes for investigative reporting it is really just an example of ignorance.

The reality is that the majority of daily market moves cannot be explained by the news of the day. Moreover, anyone who believes that a market should always rise in response to bullish news and fall in response to bearish news is either inexperienced or delusional. Markets just aren't that simple.

In the current environment it is true that a sudden decline in asset prices will often prompt strength in the US$ and a downward reaction in the gold price, but this isn't because market participants are becoming more risk averse; it's because most debts are US$-denominated. If a speculator has bought a financial asset using borrowed US dollars and something happens to make him suspect that the asset in question has begun to trend downward, then he may be prompted to sell whatever he can -- including gold -- to reduce his debt. At the same time, other speculators may well decide that gold is beginning to look more attractive due to the weakness in financial assets and the inevitable inflationary response of the monetary authorities to the weakness, thus adding to the demand for gold. Hence, developments that should EVENTUALLY put irresistible upward pressure on the gold price (due to spreading recognition of an inflation problem) can INITIALLY result in a lower gold price (due to the de-leveraging of speculators).

Further to the above, a risk for gold is that evidence of a stock market peak will bring about a wave of de-leveraging by speculators who have made leveraged bets on growth-oriented investments such as equities, high-yield bonds and industrial commodities. This could create a scaled-down version of what happened in 2008, with gold moving sharply higher relative to growth-oriented investments and initially moving lower in US$ terms. It isn't much of a risk, though, because we get the impression that Bernanke is nervously standing by the monetary pump, ready to switch it to high speed at the first sign that his cherished economic rebound is faltering. And we aren't the only ones to have that impression, judging by the increasing interest in gold being shown by some extremely well-heeled hedge fund managers. In other words, unlike July of 2008 (the starting point of the crash that took gold down along with everything else) the Fed is presently 'ultra-easy' and poised to become even 'easier' at the blink of an eye.


Steve Saville
email: sas888_hk@yahoo.com
Hong Kong

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