Gold & Silver Get Sold Heavily; Markets Erratic

September 25, 2011 07:00 PM

Gold and silver were caught in the headlights of the "Risk Off" juggernaut last week, the carnage was not helped by a poorly timed margin increase out of Comex and the Shanghai Gold Exchange. Asian markets maintained the bearish slant overnight with the NIKKEI selling off 2%. Gold was at one point off by more than $100/oz, trading at $1,550/oz, but has since staged a modest recovery and is trading now (time of writing this morning) at $1,613/oz.

Markets Move to Cash

Why Did Gold Sell Off So Aggressively?

Large liquid asset prices tend to approach efficiency, over time. When new information is ingested by the market the price of securities is adjusted up, down, or not at all. Currently markets in general are nervous, as they were caught off guard by the Fed statement last week, which outlined a weaker US economic growth forecast. Moreover, the negative sentiment is being compounded by commentary from a host of world leaders and institutions urging action on Europe and debt problems in general. At times like this, leveraged market participants (hedge funds and proprietary trading desks) must assign a fair value for the holdings they own. Trading desks must adjust books for a slower economic growth forecast, which leads to lower corporate earnings and translates into lower stock prices. The Fed comments sparked the selloff.

All this activity feeds off itself and markets can quickly find themselves in a destructive downward spiral where fairly valued assets are sold off aggressively. Margin holders of assets are forced to sell, active traders, trying to get ahead of the market, position themselves to profit from these market moves. Passive market participants, typically the general public, will then look at this market activity and consider selling as they will logically ask themselves: "What is it that the market knows that I do not?" Eventually a consensus begins to form and the volatility of the markets (the velocity of price change) begins to calm down, until the next quantum shift in market knowledge occurs.

The fundamentals underpinning gold have never been sounder. The correct price for gold is a matter of interpretation but it is fair to say the recent price moves in the metal have nothing to do with a change in the fundamentals. Indeed, the selling activity was a mass liquidation event that affected most asset classes across the board and benefited the US dollar as investors went to ground, hiding in cash.

It is important to note that the underlying problem of debt and the issuing, redemption and/or forgiveness of debt are the questions being tackled by the political classes. The world economy is at a crossroads with many sub-optimal imbalances dragging back growth. Most if not all of these imbalances are the result of parochial and ill-conceived fiscal and monetary policies of powerful countries that refused to take in account the global effects of their actions. Capital markets are increasingly taking their cues from official actions as opposed to the fundamentals. Unfortunately for policy makers, the confusion that they are inadvertently sowing, vis a vis the weaknesses of their institutions, is in itself eroding confidence and thus restraining consumer spending. Washington and Brussels are attempting to address the problem, but the question of the hour is: Do they have the political mandate to effect the necessary changes?

Mark O'Byrne is executive director of Ireland-based GoldCore.

About the Author
Stephen Flood is a director of Ireland-based GoldCore.