GOLD SELLS OFF SHARPLY, BUT LONG TERM FUNDAMENTAL THESIS HAS NOT CHANGED / SEEKING ALPHA ( A MUST READ )

Gold Sells Off Sharply, But Long-Term Fundamental Thesis Has Not Changed

by: Eric Parnell

December 15, 2011

The market has been bleeding gold this week.

It was just last Friday when the gold trade seemed to stand on steady ground. While certainly down from its late summer highs, gold (GLD, IAU, PHYS) remained fully engaged in a renewed uptrend that had gotten underway back in late September. And by the end of last week, it was comfortably nestled on its 50-day moving average.

click to enlarge


But then the current week began, and suddenly the lights went out for gold. On Monday, it plunged to support at its 150-day moving average. By Tuesday, it broke this support and closed below the 150-day M.A. for the first time since January 2009. And then Wednesday, gold sliced through another support level at its 200-day moving average. In just three trading days, gold lost -8% and helped usher out the gold bears in full force.


An important question must be asked following the dramatic events for gold over the last few days. Is the bull market in gold finally over?


I’ve owned gold for a long time. One of the first things I've always known about owning gold is that sharp sell offs like these come with the territory. Such are the risks associated with owning gold. And my reasons for owning gold stretch beyond simply trying to capitalize on price gains the yellow metal, as it also serves as an important portfolio hedge within a broader asset allocation strategy. But the fact that gold cut like a hot butter knife through several critical support levels in a matter of days must be respected, as it suggests the potential for much further downside in the days and weeks ahead.



With this in mind, my initial step is to revisit the fundamental reasons for why I own gold in the first place. More specifically, I want to determine whether some event has occurred in the last three days that has permanently altered my long-term thesis for owning gold. I previously presented these situations in a previous article posted back in late August.



First, have we seen a decisive shift to a strong dollar policy in the United States? The answer here is NO. Sure, the U.S. dollar (UUP) has strengthened meaningfully in recent days, but this has not been due to some major U.S. policy change. Instead, it has been driven by European banks scrambling to fund U.S. dollar liquidity needs.

Second, have we seen a shift toward greater fiscal and monetary prudence? The answer once again is NO. Sure, fiscal spending largesse is fading and the emphasis on austerity is building, but governments worldwide continue to struggle with actually enacting spending cuts in any meaningful way. And its not as though some fiscal policy announcement came out in the last three days that would justify the recent price plunge. Much more importantly, the potential is as high as ever for yet another massive round of quantitative easing to try and rescue the global economy from the building European crisis. So the answer here would be not only NO, but instead quite the opposite.



Third, are we suddenly entering a period of steady economic growth and price stability? That would be an unequivocal NO. Sure, U.S. economic data has shown signs of modest improvement in recent months, but a long and choppy road still lies ahead. And the mounting problems in Europe threaten to plunge the global economy into a disinflationary if not deflationary recession. Needless to say, this is certainly not the backdrop where investors are suddenly brimming with confidence about the outlook.


Thus, nothing has occurred particularly over the last three days that has changed my gold thesis. Instead, recent events out of Europe would add to my conviction for owning gold. More pointedly, if we see the collapse of a major global currency in the euro, investors will likely be fleeing desparately to safe haven stores of value such as gold. So what gives?


The answer resides with the short-term effects that can often lead to sharp sell-offs in gold that were also outlined in my previous article from late August.


Have we seen an increase in margin requirements from the exchanges? NO, but the possibility that one might soon be in the offing can never be ruled out. So while this possibility shouldn’t be completely dismissed, this is not likely the reason for the sell off.


Are we currently witnessing a major liquidity event? ABSOLUTELY. For one, major financial institutions, particularly many across Europe, have been selling gold aggressively in recent days in an effort to accumulate U.S. dollars. At the same time, a number of hedge funds have also been apparently working to unload gold positions as they wind down operations before the end of the year. And when the supply being dumped into the market by eager sellers exceeds the demand from buyers inclined to stand back and allow the liquidation to play out, this will result in a sharp decline in price. And such are primary forces behind the sell off in gold this week.


Such sharp sell offs in gold or any other asset certainly should not be ignored. And we may see further sharp declines in the gold price in the days ahead as the liquidation process plays itself out. But given the backdrop that the fundamental thesis for gold has not changed and if anything it has strengthened, such liquidation fueled corrections can provide exceptional opportunities to step in and buy gold. For once the liquidation activity has been completed, the subsequent rallies in gold have been equally explosive with the yellow metal often quickly returning to previous price levels if not beyond.


Therefore, patience with the gold trade may be rewarded in the end. Those holding gold will likely be best served by maintaining positions, as the long-term fundamental thesis has not changed and one almost never wants to stand along side those that are forced to sell into a panicked market with a dearth of buyers. And for those that have been seeking to initiate or accumulate gold positions, the recent plunge may soon provide the long awaited buying opportunity. So while managing the gold trade may become increasingly uncomfortable in the short-term, staying cool and showing patience may be rewarded once the dust settles.


Disclosure: I am long GLD.