As trading in gold begins for 2012, we see a positive pop of over 2.5% the first day back after the last day of 2011. Is this a sign of the future, or just a short-term bounce? Let’s take a look at what happened in the last few months of 2011 to understand what is most likely for gold prices in 2012.
After making the highs of the year during the August-September period in 2011, gold sold off hard, followed by a rally that did not reach previous highs in November and then the year-end sell-off. There were several different events happening behind the scenes that caused a lot of this volatility.
During the initial move up during the summer and the secondary move in November, many hedge funds have been active and heavy buyers of gold. This created problems, as many funds were leveraged heavily betting on a bullish move in gold. While a fund might be right in the long term, anytime you are heavily leveraged, it leaves you open to margin calls. When the price starts to go against your position, you are forced to sell some of your position to maintain your core position. This causes a cascade effect, as a little selling then triggers further selling. This creates more margin calls and then even more selling. This cycle continues until the most heavily leveraged holders have had their positions closed.
This forced selling also is related to losses in other parts of the portfolio. When you have a portion of your portfolio losing money, many people choose to sell the asset that is up and liquid, which gold was for most investors this year. This adds to the supply in the market.
The timing of the liquidation is quite interesting, as we see year-end selling. This is based on fund redemptions, investors wanting their money back forcing the fund forced to sell gold to raise money, and various portfolio adjustments. Also note that gold prices usually trade inversely to the U.S. dollar, as we’ve seen the euro fall apart and investors pile into the U.S. dollar, this caused even more downward pressure on gold prices.
The real question: was this sell-off in gold short-term or a sign of structural weakness in gold prices? When one looks at the reasons for the sell-off, they all point to a short-term aberration. The fundamentals still look very strong for gold prices. In fact, considering how strong we’re bouncing already, this would be a very bullish sign.
If all of the forced sellers are done, we still have an economic situation where the world central bankers are looking toward policies of printing more money and investors continue to have a lack of faith in fiat currencies. Portfolio year-end adjustments just occurred and new funds now need to be re-allocated into the market. All are bullish, long-term drivers in gold prices.
There are moments in history when short-term fluctuations provide great entries for the long-term investor. From all of the evidence, this is where gold currently stands: at a great entry point with strong fundamental drivers to push up gold prices.