Gold outperformed almost every commodity in 2011 yet the end of year sell off has left many gold investors nervous.
First of all, the out-performance of gold was due to the fact that the world is looking for an alternate currency. Every central bank from the Swiss National bank to the Indian central bank is printing money. The supply of gold increases by 3-5% per year and investment demand has been surging all over the world.
Let us first examine the gold sell-off and try to guess whether the gold market has stabilized providing gold investors with an entry point.
There were 5 main reasons for the gold sell-off in August 2011.
- gold was extended at $1900 which was an all time high
- the S&P downgrade of U.S. debt created panic buying in gold. This meltup created frenetic gold buying that subsided
- the European sovereign debt crisis likely meant that European banks were scrambling for dollar based funding
- finally there are so many technical traders in the gold market. As soon as gold broke through the 200 day moving average, these traders sold their gold
- demand from China and India subsided in Q4. For example, the Indian rupee was weak in 2011 (gold soared 31% in Rupee terms) and it became prohibitively expensive for Indians to buy gold. Gold imports tumbled 56% in India in Q4.
Looking at the Commitment of Traders report we can see that 42% of the long positions were liquidated from August 2011 into the end of the year. Leveraged hedge funds were most likely liquidating en masse in preparation of massive redemptions.
Since the year end sell-off, gold has rebounded leaving gold investors to wonder whether it is safe to plough back into the gold markets.
Looking at the above factors it is clear that gold is not overbought. If anything it is oversold with extreme negative sentiment. The scramble for funding by European banks appears to have subsided. However, we don’t know if it’s a temporary phenomena. There are a lot of European bonds that have to be rolled over in 2012. Technically, the gold market is still in a short term downtrend. Although gold has poked above the 200 day moving average it is still a broken chart. The reports of Indian and Chinese buying have yet to be released for 2012.
In sum, it appears that the gold market has stabilized around $1600. However, it does not appear that the gold price is set to rise dramatically in the next few months.
