World Gold Council points to fund liquidation, stronger dollar, stock markets
NEW YORK (MarketWatch) -- Gold is often seen as an investment safe haven whose prices tend to rise when the economy falls into troubles, but its recent slumps have defied conventional wisdom.
Gold futures hit a historic high above $1,000 an ounce a few days after Bear Stearns was taken over by JP Morgan Chase & Co. ) on March 14. But in the recent round of crises triggered by the collapse of Lehman Brothers Holdings Inc. , gold has fallen to below $730. The metal has so far lost more than $150 in October.
The reason, according to analysts at the World Gold Council, was that the latest bout of the credit crisis has been deeper and more far reaching. Funds were forced to sell desired assets such as gold to meet margin calls, while weakness in European economies lifted the U.S. dollar, which then pushed dollar-denominated gold prices lower.
"The fact that gold did not head higher during the current leg of the crisis seems to reflect a combination of the rise in the dollar, deleveraging of commodity positions, sales to meet margin calls, and the unwinding of the long gold, short dollar trade," Natalie Dempster, an analyst at the WGC, wrote in a research report released Thursday.
Unlike in March, banks and investment funds were facing an increasingly tight credit market recently. The overnight dollar London interbank offered rate, the rate banks charge each other known as Libor, hit a record high of 6.88% earlier this month. The rate was at around 3% in March.
Stocks also stood higher in March, with the Dow Jones Industrial Averagetrading around 12,000. The Dow has slumped to below 9,000 this month.
"The current crisis has seen much more pressure on gold as an 'asset of last resort,' where it has been sold to meet margin calls when there have simply been so few other viable options available," Dempster said.
Trading in the over-the-counter gold market, where big institutions trade with each other directly in large orders, weakened in the third quarter due to the rise in counterparty risk and the lack of investment capitals, according to GFMS, a London-based precious metal consultancy.
A wave of liquidations occurred in September as funds were forced to raise cash in the face of margin calls and massive investor redemptions, according to GFMS.
The London gold-fixing price -- used as a benchmark for gold's OTC trading - has dropped $140 this month. It stood at $744 an ounce Wednesday afternoon.
Gold trading in futures markets also saw a similar declining trend. In the two major global gold futures markets in New York and Tokyo, long positions, which bet on the rise of gold prices, have been falling, while short positions, which bet on falling prices, have been rising.
Some investment funds were forced to sell even their "most desired assets such as precious metals," said Peter Spina, president of GoldSeek.com. There could be "more victims of the fund collapse and more forced liquidations."
Gold futures traded on the Comex division of the New York Mercantile Exchange have been falling nine out of 10 sessions since Oct. 8. Gold closed down 32.80, or 4.3%, at $735.20 an ounce on Comex Wednesday. It fell to below $730 in electronic trading on Globex Wednesday evening. See Metals Stocks
"Investors worldwide are selling everything, including the kitchen sink, and gold is no exception," said Peter Grandich, chief commentator at Agoracom, an online marketplace for the small-cap investment community.
Dollar's rise
The U.S. dollar also played an important role in gold prices, as the greenback and the yellow metal often move in the opposite direction.
During the Bear Stearns crisis, the dollar continued its long secular decline, with the euro trading above $1.50.
The dollar, however, has seen steep rise since late September, with the euro trading below $1.30 Wednesday for the first time since February 2007. The British pound fell to the weakest level against the dollar in five years. See Currencies
A stronger dollar reduced gold's appeal as an investment alternative. "Investors unwound leveraged short dollar, long gold position, mindful of the long standing negative correlation between gold and the dollar," said the WGC's Dempster.
Some analysts said that in the long term, the U.S. rescue plans to inject liquidity into banks will stir inflation and a devaluation of the dollar -- something that would be bullish for gold prices.
"An extraordinary amount of liquidity has been pumped into the system this year," said Peter Grant, senior analyst at USAGOLD. "I anticipate further debasement of all currencies, including the dollar, which will ultimately drive gold prices higher."
