Merryn's Blog

Why is the gold price collapsing?

The price of gold has tumbled in the last day or two. But little has changed, and the same arguments for holding it still apply. So why has gold fallen so dramatically? Merryn Somerset Webb explains.

No one is particularly good at market timing, and we've always tried to make it clear that at MoneyWeek we are more investors than traders.

Still, my editor's letter last week was particularly badly timed. It was written before the nasty sell off at the end of last week and focused on how the gold mining stocks were still lagging the gold price substantially probably thanks to a lack of confidence among miners and analysts that the gold price would stay high.

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The gold price promptly fell a couple of hundred dollars. Then this morning it really tanked. When I got up we were still way above $1,600 an ounce. I follow @goldpriceUSD5 on Twitter so I get an alert every time the price rises or falls by $5. Usually this is relatively satisfying. This morning it wasn't. By the time I'd dropped the kids at school we were at $1,540.

Goldbugs have long been expecting a correction and there can't have been a chartist out there who was surprised by the mini-crash. They'd all noted that it had gone too far too fast and there was much talk about various formations that forecast a correction.

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But nonetheless, seeing the price of one of your main holdings in freefall is a pretty nasty feeling. So what's going on? If gold is the great anti-asset, the thing to hold when everything else is in collapse why is it now trading at $1,620 (back up from its lows at least) not $2,000?

All sorts of reasons. The first point to note is that this is exactly what happened in 2008. Panic begins. Traders deleverage in a flight to liquidity (cash and the US dollar in particular). And everything gets hammered in the process. In 2008 this effect on gold (it fell 30%) was pretty temporary.

It is also worth noting that when traders get margin calls (ie they have to stump up extra cash as collateral for some of their trading positions), as anyone trading silver in Shanghai did this morning, they tend to raise the cash by selling profitable positions rather than non profitable ones (who wants to book a loss?). Gold has had an amazing run so far this year so it makes sense for panicking people to take their profits on it in a hurry. The selling of winning positions like this says SocGen is "indicative of the stress the market is under."

Then there are exchange traded funds (ETFs). The sudden market understanding of the risks the global economy faces means that all the industrial metals have fallen fast (platinum, palladium, copper etc). These metals are often traded in packages or indices along with gold. So when they are sold the gold price falls along with them.

The fact is that while it would be nice if gold always went up in a crisis, short term it can get just as burnt as everything else, just as in 2008.

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So what next? I was on Moneybox on Radio 4 on Saturday saying that I am still a happy holder of gold. And I am. The only thing that could really mean that it was all over for gold would be a long period of deflation in the west. And while I'm sympathetic to the arguments for that, I am not convinced of them.

Bernanke might not have turned the printing presses in the US on last week (we got Operation Twist instead) but I bet he still has them primed and ready to go. The same goes for the Bank of England and the ECB.

In last week's MoneyWeek, we quoted James Grant as saying that the price of gold was a function of the market's trust in central banks to protect the value of our currencies. "It is one divided by T where T stands for trust. And trust is a shrinking number and will continue to shrink." I can't see how that has changed since last week.

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