Gold price plummets again as hedge funds rush for the exits

Posted by: Aaron Pressman on October 23, 2008

There’s still plenty of fear and even panic evident in stock markets around the world but the safest of safe havens, gold, isn’t getting much love. In trading today, gold dropped below $700 an ounce for the first time in over a year, marking a huge retracement of the multi-year rally that saw the precious metal peak at an all-time high of over $1,000 back in March.

What’s going on? On the one hand, the risks that investors typically try to use gold to counteract — inflation and a weakening dollar — are diminishing. And at the same time, a lot of big investors that used borrowed money to juice bets on commodities including gold are pulling back and unwinding their trades.

Consider these two graphs which plot the price over the past three months of the SPDR Gold Trust (Symbol: GLD) against the Powershares DB US Dollar Index Bullish fund (UUP) and the United States Oil Fund (USO):


golddollarjpg.jpg


goldoiljpg.jpg

The rising value of the dollar and the cratering price of oil have helped reassure investors that, at least for now, inflation and currency devaluation aren’t big risks ahead. In fact, much of the worry of late is of deflation and depressions.

Gold is acting as it almost always does, moving in the exact opposite direction of the value of the dollar. In large part, you can blame the slowing world economy for that. With many nations, not just the United States, now facing recessionary times, the dollar looks a little more appealing as a place to ride out the storm. And demand for all sorts of commodities used in industry is plummetting, hurting both commodity prices and the currencies of commodity producers like Canada, Norway and much of Latin America.

But another explanation behind the recent moves of all these currencies and commodities is the unwinding of a popular and, no doubt, highly-leveraged trade used by hedge funds, Wall Street firms and other big investors. For the past few years, it was a great idea to borrow money in currencies with low interest rates, like the US dollar, and invest either in commodities or in currencies from major commodity producers. As long as interest rates stayed low and the dollar stayed weak while commodity prices kept rising, the trade paid off. But when the dollar began rallying and the economic outlook deteriorated, that bet was a huge loser. With added pressure to pay back borrowed money from credit crunched lenders, the big players had to exit their positions in a hurry.

None of this is to say that the markets are always right. With the U.S. government putting trillions of dollars on the line to restore faith in the banking system, the future value of the dollar has to be in question and the possibility of rampant future inflation can’t be discounted. There’s also been a huge disconnect between the falling price of gold futures contracts and seemingly insatiable demand for gold bullion coins and bars from retail investors around the world. That suggests there may be plenty of the kind of fear that pushes gold prices higher waiting for the short-term selling to end.

Reader Comments

AnnInFL

October 23, 2008 1:55 PM

Great article. I think this pretty much says it all.

Forbes Called It

October 23, 2008 3:12 PM

Steve Forbes references the impetus for the initial rise in the price of gold in this great piece:

http://www.forbes.com/hcome/forbes/2008/1110/018.html

Definitely a piece worth reading and forwarding. Forbes makes a strong argument against reactionary regulation. His argument is based on US economic history of slumps (1930s, 1970s) and periods of growth, especially 1980-2007. The slumps are all correlated with periods of overregulation and the growth periods are tied to easing restrictive regulations.

Forbes states that the impetus for the initial rise in gold prices (and other commodities) was the Fed's "fateful miscalculation" to keep interest rates artificially low. He's dead on.

Forbe's piece is much better-rounded than my synopsis. Read it and fight reactionary regulation.

http://www.forbes.com/hcome/forbes/2008/1110/018.html

bobmcalister

October 23, 2008 3:58 PM

cant pass this up

lets see...we have a gadzillion pieces of paper out there with no REAL value, and the Gubment printing more and more so the banks can have more so they can create More of these peices of paper ...

now ...wonder if the pieces of paper are gonna be any good...have any VALUE?

this move is simply a move to shake out the doubters...and then up we go in gold ...down in the dumps for the dollar

this country is broke.

Jim

October 23, 2008 5:23 PM

Gold is one of the commodity that has been played WS by speculators, it is not based on demand, but based on speculators games.

AS we all aware Wall Street has became casino, WS should be moved to Las Vegas. Aren't you all agree?

billd

October 23, 2008 7:23 PM

The dollar is up because the de-leveraging hedge funds had to buy dollars as they unwound their trades. Now, this is mostly done, and the counter trend bull rally in the dollar in a secular bear market is finished. Now, expect the dollar to fall and gold to rise along with oil and the stock market. The US Dollar index is heading for 62.

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About

Bloomberg Businessweek’s Ben Steverman focuses on the latest moves in financial markets and emerging trends in stocks, bonds, and funds, always with an eye toward giving readers a better understanding of the sometimes confusing and often chaotic world of money. Standard & Poor’s senior index analyst Howard Silverblatt will also provide his take on companies’ finances and the markets. Voted one of the “Top 100 Finance Blogs” in 2007.

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