Bears slam gold price

Gold bugs have been taking a beating of late, and it just seems to be going from bad to worse. The gold price entered official bear territory to close out the trading week, and then began the week by falling even further on panic selling.

At press time the metal’s price had fallen more than 28% from US$1,924 per oz. on Sept. 9, 2011.

The second wave of selling came as commodities gave up ground on the back of poor economic numbers from China.

Gold bugs are particularly concerned that one of their central tenets — that demand will come from central-bank buying, as emerging global players tire of the U.S. greenback — is under attack, with the reverse scenario seeming to be playing out.  Fear of central bank selling is sending the gold price down, and has many onlookers worried that it could lead to a complete collapse of the commodity’s price.

So as the yellow metal fell below US$1,400 per oz. for the first time since May 2011, market watchers were pointing to Cyprus as the culprit. As part of its recent bailout from the European Union, the tiny country has to pony up its fair share of the coin, and rumour has it that the central bank will sell some of its gold reserves to do it.

While this amount isn’t enough to cause significant oversupply in the market — it is estimated that the country could sell 10 tonnes — such a sale would trigger fears that other countries also desperate to raise money may resort to similar tactics.  And if the market dips this much on a relatively small-scale threat, what will it do if countries like Portugal and Ireland, or even large-scale gold hoarders like Italy, turn to selling?

After all, central bank selling was seen as a big reason for soft gold prices through the latter part of the 1990s.

Not that the situation now is an exact parallel. First off, it isn’t even certain that central banks like Cyprus will be sellers. The recent downward movement in gold prices is being attributed to the likelihood that Cyprus will be a seller, but Cyprus’ central bank itself, officially at least, says it is not planning on selling the metal.

Still, the rumours found fertile ground given two recent bearish reports that forecast a steep decline in gold prices. The first came over a week ago from Société Générale (SocGen). The second came a week later from Goldman Sachs Group (GS-N). Both predicted serious declines in the metal’s price, as supply outstrips demand and economic recovery in the U.S. leads to a winding down of quantitative easing and a tightened money supply.

In between the two reports, minutes leaked from the U.S. Fed’s mid-March policy meeting. While the minutes didn’t reveal anything directly about the plan for quantitative easing, they did mention that some participants were in favour of ending the policy soon.

While this is hardly definitive proof of what will happen — a group of economists gathered in a room are bound to have different opinions — in the current environment, it added more fuel to the bear fire.

Others joining the gold bear camp include Credit Suisse Group (CS-N), Danske Bank and BNP Paribas. All of them forecast lower prices for the metal in 2014 relative to this year’s average price.

Of course there are still sound arguments against the current tide.

Sprott Resource’s (SCP-T) David Franklin and David Baker offered a retort to the SocGen report shortly after it came out.  The two argued that the mistake SocGen and others in the bear camp are making is that they are treating gold like just another commodity, and are deriving their forecasts from simple supply and demand fundamentals.

The Sprott report counters that gold is a currency, and because it is never really consumed, it doesn’t abide by the same underlying principles that drive other commodity prices.

Instead they argue the price is directly tied to printing money. Print more money, and the value of gold rises. “It’s really a very simple and intuitive relationship — as it should be,” they write.

The idea is that even though there has been an uptick in gold supply, relative to fiat currency, gold production will always pale in comparison. So as long as governments keep trying to print themselves out of the mess they are in, the price of gold will continue to rise.

The report ties gold’s recent sell-off to a surprising contraction of central bank assets — on the whole, central banks have been buying assets and pulling money out of the system — over the last three months. While the report doesn’t offer an explanation for the activity, it treats it as a short-term blip and points to Japan’s recent large-scale quantitative easing program as evidence that the overall trend involves printing, and devaluing fiat currencies.

Goldman doesn’t entirely disagree. But while it concurs that printing will lead to inflation and consequently higher gold prices, it doesn’t believe this cycle will begin until several years from now.