Gold Price Volatility

Gold Price in a Liquidity Trap

The gold price was in focus this week, recording some unusual volatility levels, and giving trading models all over the world a good workout. Front month volatility in equity markets is grinding lower once again, although the later months have shown no signs of declining, suggesting the market isn't rife with complacency just yet. And why would it be? A liquidity vacuum on Wednesday drove precious metal prices lower by 5%, but if you were caught in it at least be reassured by the fact that it no doubt hurt Paulson far more than you.


This week's post looks at that event, and what it could mean for gold (and to a lesser extent silver) going forward. It certainly wasn't a fluke, and although prices have rebounded slightly since, the tight trading range indicates that the market is still wary.

Gold Price Moves

The move saw gold prices fall from $1760 to $1680 on very little volume and in a surprisingly short space of time, primarily triggered by Bernanke's comments. His suggestion was that US inflation was stable and economic growth was acceptable, giving no mention or cause for introducing a third round of stimulus. Gold is traditionally bought as a safe haven asset, as a storage of wealth when times are toughest, and as a hedge against inflation. An end to large scale quantitative easing means that the economy is recovering, and there is one less piece of stimulus to cause an inflationary spike (although crude oil could single handedly change that at this rate).
 

The other cause for the sharp declines was the lack of market participants willing to buy into the selloff on fundamentals – one bearish comment and no one was prepared to put their money where their mouth was. And I wouldn’t either to be honest. Gold has rallied close to 15% in the last few months, and a healthy correction certainly wouldn’t represent an outlier event. The market had been caught very long, mostly through speculative buyers, and when that happens there can be very little support in falling markets. 

From here, gold will certainly see large scale selling into any big rallies, unless the fundamentals driving the gold price change dramatically. Now people know there are open pockets of space out there , caution levels rise dramatically. It’s not that dissimilar to when a shark is spotted in open water. The chances of coming across it are as minute as ever before, but the recent reminder that it exists is enough to drive off the marginal swimmer. A higher gold price is still on the cards, but the recovery will be slow. Its correlation with equity markets still remains strong, and low interest rates mean cheaper funding costs for leveraged buyers, so there’s no reason not to be a cautious long in this market.

In the pipeline: Uranium prices – where next?

Bullish on: EURUSD (short term, positive LTRO and European bond yields staying low should help the currency move higher)

Bearish on: US Treasuries (yields have moved higher but are still lagging equity markets, suggesting there is still some outperformance to come)

As always, feel free to leave any comments or feedback that you may have.