Bears stalk fading gold market

Bears are prowling the gold market, growing bolder in their predictions that the bull run for bullion is over.

Goldman Sachs last week became the latest to join the bears’ camp, advising clients to short gold and predicting that the price will fall to $1,450 an ounce by December and further decline to $1,270 by the end of 2014.

Société Générale, which has also declared “an end to the gold era”, is even more negative. It predicts that the gold price will drop to $1,375 an ounce by the end of 2013.

Both argue outflows this year from gold exchange traded funds and shifts in hedge funds’ positions reflect weakening confidence in the metal’s outlook.

Hedge funds have run a net long position in gold futures on the Comex market in New York since 2001. That has now dropped to its lowest level for more than four years.

Gold ETF holdings have been much less volatile than the futures market, which is why analysts are watching the latest developments so carefully.

Holdings in gold ETFs ended last year at a record 2,767 tonnes, according to Barclays Capital. But investors have withdrawn around 225 tonnes so far this year, with February registering a record monthly withdrawal of 111 tonnes.

“If we continue to see outflows from ETFs, the impact could be devastating for gold,” says Michael Haigh, head of commodities research at SG.

Damien Courvalin, commodities analyst at Goldman, says recent ETF outflows have been “significantly faster than we had expected”.

He also warns that if ETF outflows continue at their current rate, this would result in even lower prices.

Investors in gold ETFs have earned a reputation for being “sticky” and reluctant to sell even during periods in which the gold price fell.

“The bulk of ETF investors have a proven ‘buy-and-hold’ mentality and are content to hold on to their positions, despite recent price weakness,” says James Steel, precious metals analyst at HSBC.

Suki Cooper, precious metals analyst at Barclays Capital, adds that dips in gold prices last year were often accompanied by fresh buying interest in gold ETFs.

“Previous sell-offs in gold have not triggered ETF exits,” agrees Mr Haigh, noting that most ETF investors are institutions and speculative holdings in these vehicles are thought to be small.

But analysts are clearly concerned that this time could be different, with ETF investors’ tenacity likely to be sorely tested if the gold price sinks further.

Barclays estimates that a net 320 tonnes of ETF holdings were bought when gold traded above $1,500 an ounce.

Gold ended Friday’s session in New York at $1,478.35 an ounce, down 11.7 per cent this year, and any sustained retreat below the $1,500 level would leave those ETF holdings well under water.

In early trading in London on Monday, gold prices weakened further, dropping to a low of $1,403.90 and threatening to drop below the $1,400 an ounce level before recovering slightly to $1,410.

“ETF outflows remain the largest downside risk to gold prices,” says Ms Cooper, who believes the rally in the US stock market to an all-time high has encouraged further selling by gold ETF holders.

Acting as counterweights to ETF outflows have been stronger than expected demand from China this year and expectations that jewellery buying will rise during the important Indian Akshaya Tritiya festival in April. However, these supportive factors need to strengthen further to offset the weight of ETF outflows fully.

Buying by central banks (532 tonnes in 2012) also provides another pillar of support. However, the latest event to spook investors were reports this week that Cyprus planned to sell 10 tonnes of gold reserves, out of a total 13.9 tonnes, to raise cash. The central bank of Cyprus later denied the reports.

However, the prospect of Cypriot selling combined with the comments from the latest US Federal Reserve meeting, which raised the possibility of an earlier than expected end to quantitative easing, were enough to unnerve investors. They reacted by selling around 23.6 tonnes from their ETF holdings.

The mooted sale by Cyprus would be easily absorbed by the market as it is small, but it has again raised the possibility that other eurozone countries might liquidate some of their gold reserves.

Mr Steel says central banks will remain significant buyers of gold in 2013, forecasting purchases of 450 tonnes, providing a vital bulwark for the market.

HSBC recently trimmed its 2013 average gold price prediction from $1,760 to $1,700. Mr Steel says he expects to see prices recover in the second half of the year, fuelled by the continuation of loose monetary policies and concerns about rising inflationary pressures, worries about currency wars, and geopolitical tensions such as those currently affecting the Korean peninsula.

Gold prices and ETF flows updated since this story was first published.