Gold Prices Plummet: The Beginning of the End?

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There were definitely more sellers than buyers in the gold market today as the precious metal declined by more than $100 per ounce and slid below the $1,400/ounce level in US trading following the 4.1% loss seen on April 12.

Gold Prices Plummet: The Beginning of the End?

“It’s a slaughter. It all comes via the futures market. On Friday, more than 1,100 tons of paper gold had been traded. That is more than annual gold demand from China or India. I can’t see a fundamental reason for this, to be honest,” said Carsten Fritsch, senior commodity analyst at Commerzbank AG.

Market participants are worried that gold demand may be reduced by slower purchases from China and India, sale of the yellow metal by European investors due to fears of tighter US central bank policy, and increased supply caused by Cyprus selling part of its gold reserves to fund its bailout package. According, investment banks, including Goldman Sacks, reduced their gold target prices.

Last week’s and today’s price drops may indicate the start of a bear market for gold, as it has broken a key support level of $1,400/ounce. Panic selling has accelerated this break, and could continue in the short term as market participants are wary of gold’s direction and see selling opportunities now.

Price Performance Chart

Chart as of April 15, 2013

Gold bulls argue that reasons for owning gold have evolved over the years, and remain valid:

Safe Haven: Cyprus situation and ongoing European debt crisis highlights gold’s role as a safe haven investment. As long as there are financial crashes, there will be a demand for gold during such times. Hence, central banks will keep gold reserves to protect themselves against financial calamity. For investors, keeping a small allocation to gold may help protect against downward currency fluctuations and sovereign debt downgrades (e.g. U.S. getting downgraded).

Luxury Metal: Gold is still used as a status symbol and as decoration for wealthy homes and lavish events. Demand for luxury goods is less sensitive to economic downturns, as the wealthy are less affected relative to the general population.

Also, if prices remain low (below $1400/ounce), gold producers may scale back production reducing supply and helping a price recovery. Production of gold at low prices will likely not yield enough profit for gold miners to produce gold.

Gold bulls, such as Julian Jessop of Capital Economics, said that fears of US Federal Reserve tightening and Cyprus gold reserve sales are overblown. Jessop stated “The US monetary base is still on course for around $3.5 trillion, which…at face value, would be consistent with a gold price of $2,000 per ounce. What’s more, other major central banks, including the Bank of Japan and the Bank of England, are set to ease further.” He also added that an early ending to U.S. QE 3 and/or worsening of European debt crisis will add additional volatility to financial markets boosting gold’s price.

Finally, note that gold is not the only commodity hit by the price slump. Base metals such as copper and commodities such as oil have also suffered declines.

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