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, falling more than 20% from its peak, crashing through the psychological barrier of US$1,500 per oz. and closing at US$1,482.40 per oz. on Friday.

Also of concern for gold bugs is that one of their central tenets — that demand will come from central bank buying as emerging global players’ tire of the US greenback — is under direct attack with the reverse scenario seeming to be playing out. To wit, it is a fear of central bank selling that 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$1,500 per oz. for the first time since July of 2011 market watchers were pointing to Cyprus as the culprit. As part of its recent bail-out from the EU, the tiny country has to pony up its fair share of the coin, and the rumor mill has it that its central bank will turn to selling some of its gold reserves to do it.

And while that amount isn’t, in-and-of-itself, enough to cause significant over-supply 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 the threat of such a relatively small sale, 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. Indeed the recent downward movement in gold prices is being attributed to the likelihood that Cyprus will be a seller. Cyprus’s central bank itself, officially at least, says it is not planning on selling the metal.

Still the rumors 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 eventually tightening of the money supply.

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

While that is hardly definitive proof of what will happen — a group of economists gathered in a room are bound to have a range of opinion — 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 as 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 fundamental principles that other commodity prices are driven by.

Instead they argue the price is directly tied to the printing of 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 up tick in gold supply, relative to fiat currency, gold production will always pale in comparison. So as long as governments continue to try to print themselves out of the mess they are in, the price of gold will continue to rise.

The report ties the recent sell off of gold to a surprising contraction of central bank assets (that is on the whole central banks have been buying assets, thus 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 announcement of a large scale quantitative easing program as evidence that the overall trend continues to be one of printing, and devaluing fiat currencies.

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