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All that Glitters is not Gold…

All that Glitters is not Gold…

When gold prices delivered a return of nearly 650% between 2001 and 2011, people became more and more greedy and decided to time the trade believing that there was still a lot of shine left to be polished off.

Two views of the gold crash…

  • Warren Buffet is not a gold digger. It is more likely he slept over the recent gold crash. He doesn’t rely on the wisdom of Wall Street’s coffee vendor or the hot tips available at the water cooler. But a lot happens over coffee in the stock market and that’s why gold hit the rock bottom recently.
  • It’s not always that one man loses a billion dollars in a few days. So when John Paulson, America’s best known hedge fund managers became poorer by a billion, you know Godzilla has come to town.

Godzilla checked in on April 10 and Japan went overboard, causing the biggest single one-day gold sell off in three decades and also the biggest decline in gold prices in three decades.

Why did the Japs jump the (golden) gun? The short answer is: Abenomics, introduced by the new dispensation of Prime Minister, Shinzo Abe and Haruhiko Kurodo, the Bank of Japan’s new governor and Tokyo’s very own Paul Bernanke. The duo announced radical monetary easing measures to beat deflation crippling the country. In popular perception and the wisdom of market analysts this was a clean break from the past. A girlie band even pledged to remove their skirts if the Nikkei (Japan’s benchmark share index) hit 13,000 after the central bank’s announcement. Well, as it transpired, both delivered.

What goes round comes round. When gold prices delivered a return of nearly 650% between 2001 and 2011, people became more and more greedy and decided to time the trade believing that there was still a lot of shine left to be polished off. But April after all is a Fool’s month. As Wall Street numbers showed, gold futures for April delivery fell 9.4%. The slide continued with gold prices declining by more than an ounce, a record skid since the futures began trading in the U.S. in 1974.

Warren Buffet will tell you that oil and copper and not gold has more utility. As he famously said once, “Gold gets dug out of the ground in Africa, or someplace. Then we melt it down, dig another hole, bury it again and pay people to stand around guarding it. It has no utility. Anyone watching from Mars would be scratching their head.”

You can have all the gold you want and keep it, but that’s about it, isn’t it? Does it pay you a dividend? No. Does it power the economy like say, oil? No.

Does this explain the recent gold crash? Not by a long mile. There are several reasons why there has been a run on the gold and all we can do is to try and find a common thread. So here go…

Why Gold Crashed

  • Cyprus decides to sell 10 tonnes of gold reserves after the bailout, following Italy’s central bank’s decision to dump its gold in the market.
  • Japan’s Abenomics policy of quantitative easing to beat down its deflationary economy.
  • The US Federal Reserve’s bid to drive down gold prices so as to get people to buy more dollars and shore up its demand.
  • A growing preference for virtual currencies fueled by investors’ reluctance to hold conventional currency assets, as revealed by the sharp rise in Bitcoin virtual currency by ten times its price to from the start of the year.
  • Conspiracy theories manipulating the markets to create a crisis that can soon morph into an opportunity to make money.
  • Disturbing reports hinting at certain definite weaknesses in the Chinese economy.
  • Global commodity market analysts started downgrading gold, including Goldman.

Do you see the common thread in these blink and miss developments? April 10, Cyprus sells gold to meet the euro zone bailout conditions. Italy, another cash-strapped euro zone country and a big holder of gold, follows suit. The same day, the US Fed Reserves announces it will end its bond-buying by year-end and reduce inflationary pressure. And Goldman downgrades gold.

So was the gold crash really a black swan incident and impossible to predict?

History tells us that there were only three periods when gold declined significantly. The first was inspired by spiraling high interest rates during 1980-82 introduced to beat down double-digit inflation, and the second was during the infamous worldwide recession and credit crunch of 2008, while the third period began in 2011 when gold peaked at an ounce and since then fell to Interestingly, this crash coincided with a slew of quantitative easing coupled with a low interest rate regime.

Analyzing all these dips together, it can be deduced that fears of short-term deflation, gold dumping by central banks, global economic slowdown, and especially slowing economies in countries that are traditional gold buyers (like China and India) are behind the current gold decline.

To cut out the clutter and cut to the chase, the Main Street generally follows a herd mentality. The big boys may be up to their noses with tactical overlays, risk management metrics, portfolio remixes, hedging, and other impressive sounding stuff, but at the first sight of a “book” being passed in Wall Street, the sale sooner than not turns into a fire sale. Program selling kicks in, bids walk away, and before you finish your lunch, half the market has vanished.

The time is thus ripe for the big boys to pull out their toys and time the market. Hint: Actively short gold to drive prices even lower in the immediate future – and laugh all the way to the bank.

Wall Street is not always smarter than Main Street. They need you to butter their bread, but what if you stick it out and played your own game? Smart investors do this. They listen to all the experts and then game the play their way. Example: DIY trailing stops (in common parlance, stop loss orders). This way, you end up losing lesser than the rest, and if you are smarter, profit from the price-drops.

With gold losing its sheen so rapidly, it is customary to blow the whistle and sing, ‘The End of the Golden Era’. But should you mistake this for good old common sense? Hint: The Wall Street has a better record of telling one thing and doing something else.

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