Gold had its biggest one-day loss in almost three years yesterday. The question is why. There was no shortage of explanations (as usual). The main theme was that the dollar is getting stronger partly due to sterling weakness on new Brexit fears. The market also took the view that a December rate hike is likely (we agree) and higher rates also add to dollar strength.
The dollar price of gold is simply the inverse of dollar strength. A strong dollar means a lower dollar price for gold, and a weak dollar means a higher dollar price for gold. There's more to the picture, but that's a good place to start any analysis.
This sentiment was captured in a quote in The Wall Street Journal from a respected commentator:
“The market is coming to terms with what may be a new burst of dollar strength and a U.S. economy that is strong enough to bear an interest rate increase,” says Linn Group strategist Ira Epstein. “This is where you step away from gold.”
The problems with this analysis begin with flaws in the assumptions. The first flaw is that a Fed rate hike is a sign of economic strength. Normally, that would be the case, but not this time.
The Fed is actually hiking into economic weakness because they want to raise rates before the next recession hits, so they can lower them in the recession. If that sounds like hitting yourself in the head with a hammer because it feels good when you stop, you're right, but that is what the Fed is doing.
A rate hike is a replay of the Fed blunder in 2015. By raising rates while the economy is still weak, the Fed will cause a stock market correction (or worse) and cause a flight to gold as a safe haven — exactly what happened in December 2015, the last time the Fed hiked rates. By raising rates while the economy is still weak, the Fed will cause a stock market correction (or worse) and cause a flight to gold as a safe haven — exactly what happened in December 2015, the last time the Fed hiked rates.
Once the stock market tanks and the economy flirts with recession (if we're not already in one), the Fed will quickly revert to its dovish mode and start to weaken the dollar as part of the ongoing currency wars. Then gold will be off to the races again, with miners going up even more.
Tuesday's drawdown in the gold price was also a reflection of "weak hands" getting washed out of the market. The weak hands are those in the paper gold markets such as gold futures and ETFs that are using margin or derivatives (such as options).
Their losses are magnified by the use of leverage, and they are forced to put up fresh margin money or face liquidation. Often, these weak hands dump their positions as fast as possible. That selling begets more selling, which feeds on itself and so on until the market finds a new level.
London-based gold guru Andrew Maguire said this last night:
Close to a staggering 1,000 tonnes of paper gold has been rinsed out in the paper gold markets today… This takedown is a complete joke, and the wholesale market is all over this paper takedown. This is a desperate effort by Western officials to cover massive pre-Brexit short positions put on by their agent bullion banks near the $1,275 level.
Maguire hammered the point that “Western officials” deliberately waited for a Chinese holiday before smacking down on gold-silver prices. Still, China will be back to business on Sunday night, buying gold and surely capitalizing on the gold discount. Meanwhile, the ever-vigilant People’s Bank of China (PBOC) is not asleep at the throttle, and was yesterday actively buying gold into this dip.
My senior geologist for Rickards’ Gold Speculator, Byron King, had this to say:
My contacts across the industry — from mines in the desert to trading floors across the world — believe that yesterday’s gold price crash was a manipulated event, designed to flush out paper traders with weak hands. Gold prices should firm up and consolidate, and then the yellow metal will make its next move upward. Right now is a buying opportunity for everything on the shopping list.
The rate hike/strong-dollar scenario is strictly temporary. Soon the reality of lower growth, lower rates and a weaker dollar will sink in. Then gold will make up today's lost ground and surge higher.
I was on a conference call Tuesday morning when I first noticed the price action in gold. As soon as I finished that call, I dialed my dealer and bought more physical gold. I consider this lower price point a gift and an opportunity to add to my allocation at an attractive level. You should too.
Below, I show you how China takes advantage of opportunities like these to accumulate gold to gain greater influence in the world’s monetary affairs. And that’s not good for the dollar. Read on.
Regards,
Jim Rickards
for The Daily Reckoning
P.S. This could be the best buying opportunity we see for a very long time. If you haven’t bought gold yet, what are you waiting for? It’s also the perfect time to buy more gold if you already own some. I called my own dealer yesterday to buy more gold myself.
I’m so confident gold’s due for a major turnaround I’m doing something incredible. In short, I’m putting my money where my mouth is. And you get to benefit from it. My publisher thinks I’m nuts for doing it, saying I’m giving away the store. But that’s how convinced I am in my thesis.
You need to hurry. The window is closing fast, and I’m only keeping this offer open until tomorrow, Oct. 6. .