It has been an awful week for gold prices. Despite bullish predictions for gold from Denver Gold Show, a recent survey by Bloomberg and strong predictions by gold bulls, gold fell like all commodities and other asset classes (except US treasuries) last week. In the last 30 days gold prices have dropped 10%. In the last one week gold has declined over $120. This has lead investors to ask whether the decade long bull run on gold is over?
One way to try to answer this question is to look at historical price movements in gold prices. On Monday gold touched a low of $1535 an ounce, a 20% decline from its peak of $1920 which it touched recently. In May to June 2006 gold had declined 25% and more recently in October 20008 during the Lehman crash it declined 27%, after the worldwide stampede to cash to preserve liquidity. Interestingly after all these bouts of decline, gold did manage to come back strongly. Even now on a yearly basis gold is up 27%!.
In our view one of the reasons for the volatility in gold prices is the huge amount of paper or financial trading which happens in gold and other precious metals. This financial trading has brought significant volatility in the price of gold. Financial transactions in gold contracts now set the price of gold on a daily basis and seem to have nothing to do with physical gold trading fundamentals. Just to give a context, the LBMA (London Bullion Market) on average traded around 20 million ounces of gold per day in July 2011 (source: http://uk.finance.yahoo.com/news/Gold-transfers-rise-July-LBMA-targetukfocus-2412619597.html?x=0). This is an astounding figure when one considers that the annual gold production is around 85 million ounces. So the actual gold production in a year is less than a week’s trading in gold financial contracts in London market. Keep in mind that there are other markets like COMEX, ETFs etc that also see lot of trading in gold. (This point was also mentioned by Eric Sprott in their “Markets at a Glance” paper )
Chicago Mercantile Exchange recently raised their margin requirement for gold and silver contracts. Margin rates determine how much money someone has to pay up front in order to secure a gold order. Shanghai Gold Exchange also raised their margin requirements. No wonder that we are seeing volatility and correction in gold prices. If anything this correction is overdue as gold has had a good run and letting of some steam is good for gold prices to stabilize and eventually move up from these levels (why it will move up is a topic for another day). Having said that, the recent correction had done some serious damage to the widely held view that gold is a safe haven (an asset class which will hold up when all else fails).
Gold is subject to similar volatility like other asset classes, given that the financial and speculative transactions on gold contracts now dwarf the physical trading in gold. But, in this confusing time period let us not forget that gold was trading above $250 in 2001. Also even at $1500 an ounce, gold miners are making money hand over fist and they will need to add gold reserve ounces that will make them pursue quality juniors with ounces in the ground or juniors with rising production profile. Junior gold companies covered by Ubika Research available at http://www.smallcappower.com/AllCompanies.aspx#analystresearchcoverage is a good place to start looking for quality gold juniors.
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