Last month, gold prices fell dramatically by 17 per cent in just three trading days on the suggestion by the European Commission (EC) that Cyprus should sell Euro 400 million of gold (just 10 tonnes at that point). However, a closer look at net long positions on Comex, in gold exchange traded fund holdings (ETF) and macros, reveals that the writing was on the wall for gold prices at least to have ended their bull run, if not for a fall of such magnitude and speed.
The net long position on Comex on April 9 was just 64 per cent of the 2009 to 2012 average; over which period the price of gold had risen 90 per cent. The outright short positions had touched 390 tonnes on February 19, 2013, the highest since July 1999. And it needed a crash in prices for the short position to move past the high of February, indicating nervousness amongst professional investors in the aftermath of the fall. A look at trends in gold ETFs reveals that 203.3 tonnes of holdings were shed in the year to April 9, averaging 2.9 tonnes per day. And in the days during the crash, the average daily sales touched 12.2 tonnes. However, this doesn't necessarily reflect large scale disenchantment with gold as some investors are believed to have moved metal from ETFs into allocated or unallocated accounts.
How important was the EC's trigger? Article seven of the Protocol of the European System of Central Banks and of the European Central Bank (December 2004) establishes the independence of central banks in accordance with Article 108 of the Treaty of Rome. As this means politicians are prohibited from influencing members of the decision making bodies of the ECB or of the national central banks in the performance of their tasks, in principle this means Cyprus need not sell gold in response to the EC's suggestion. Separately, the Swiss People's Party said recently it has enough signatures to force a referendum that, if voted through, would require the SNB to hold at least 20 per cent of its assets in gold; it would also ban the bank from selling gold subsequently. The chairman of the SNB was swift to respond, saying any such move could hinder Swiss monetary policy. Overall, we expect the official sector to be a large-scale net purchaser of gold this year at an average pace of 100-150 tonnes per quarter.
On the macro front, the rally in the broader risk markets, and with inflation less of a concern than hitherto, there has been a rise in investor risk appetite since the beginning of the year. The IMF Financial Stability report released on April 15 also strikes a similar chord by observing that, "Acute short-term stability risks have declined in the euro area on the back of strong policy action." However, we expect these greenshoots to be short-lived as the recent interest rate cut by ECB, and the rising probability of the Fed's continuation of its easing programmes, point to a shift in favour for gold investment.
More importantly, the surge in physical demand following the recent price fall has led to shortages of gold across most key consuming countries since late April, leading to higher premia and refiners running at full capacity. We believe these reactions should support gold at Rs 24,000/10g in the near term and provide a base for rallies towards Rs 27,500/10g over the next three months.
The writer is precious metals analyst, GFMS - Thomson Reuters Commodities Research & Forecast
