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Going for gold

Gold prices are down, attracting buyers, but liquidation is ongoing for ETF and ETP holders.

April 21, 2013 7:03 by

I never thought that I would write so enthusiastically about a week in which the gold price lost just shy of US$75. The week started with the huge sell-off, bringing prices down to the US$1325 level, only to be repeated the following day, with sweeps down to the US$1335 level. However, there was and is, some light at the end of the tunnel, as unprecedented physical demand from all over the world started to take advantage of these “low” prices.

The situation in Dubai has surely been similar to all over the world, where smallish discounts against loco London prices changed into decent premiums for physical gold. Dubai moved from a discount of US$0.50 to a premium of between US$2 and US$3 per ounce of gold. The Dubai Gold Souk, based on anecdotal evidence, looked more like a busy Central Train station, with buyers clearly in the driving seat.

The other side of the coin is the ongoing liquidation from ETF and other ETP holders. The liquidation seen was magnified by increased margin requirements from various exchanges and the volumes traded were massive. The Commodity Exchange (Comex), a division of the CME Group, recorded just over 700,000 contracts traded for the active June Gold contract, on Monday (April 15, 2013). This was reduced to 425,000 contracts on Tuesday, with a falling tendency, which culminated last Friday (April 19, 2013) with a volume of 189,000 traded contracts. For your guidance, 200,000 contracts represent a very active normal trading day. Gold prices have been able to recover just over US$80 from the lows, but it failed to close above the US$1400 level on Friday, during the important Comex session. The settlement price for the active June gold futures contract is US$1395.60 per ounce and that does not convince me yet that the worst is already over.

A confirmed close above US$1400 is, in my opinion, needed before a more confidence building scenario can be achieved. Volatilities for gold rallied to levels above 30 per cent early in the week, in order to close the week in the low twenties. Last week’s trading span has been huge, with ranges between US$50 and US$100 being the norm, during the trading day. Next week promises to be equally busy and it will be key to note if the physical markets can still rise to the challenge and take up the slack, which will keep coming from the derivative markets.

Lastly, I want to bring in the thought, that a significant amount of gold mining companies will start seeing negative cash flow scenarios, if prices do establish themselves around, or even under the US$1300 level. This would lead over the medium term to production curtailments and should be supportive to the market. There have been several comments from the official sector that they will look positively towards increasing their purchases of gold and take advantage of the current price level. It does come as a bit of surprise to me how quickly a lot of people suddenly see no reason to hold gold any longer, and to invest heavily into equities.

The economic numbers which I am looking at, especially from the US, are better than some time ago, but they are by no means convincing and clear cut. The latest Commitment of Traders Report (COTR) (end of business day April 16, 2013), shows a large decrease of long positions, while short positions have also decreased. This appears odd, after the price action seen, but this could be the result of spread trading instead of outright futures sales.

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