HSBC says gold’s plunge to two-year lows is the result of liquidation of exchange-traded products and a general commodity retracement, but looks for a “slow grind higher” as the physical market reacts to the sell-off.
The bank issued a special report Monday describing the decline from the last two trading days as the biggest two-day fall in 30 years.
HSBC listed a number of factors influencing bullion, including minutes of a March meeting of the Federal Open Market Committee released last week showing some members favour an early end to quantitative easing. Other factors include a shift out of commodities into equities and bonds, ongoing ETF liquidation and a reduction in speculative net length on Comex, worries that Cyprus will be forced to sell gold and other countries will follow suit to restore sovereign balance sheets, plus the break of technical and psychological support at $1,525 and $1,500 last week. Some also argue falling inflation expectations, although HSBC says this is not the case based on break-even rates.
“Some of these reasons are more powerful than others,” HSBC said. “None of them in isolation truly explains the violence of the move. This type of capitulation needs significant selling by the major players in the market. These sales are fast and large whilst the real buyers are slow and small. Over time, the slow and small over should re-establish an uptrend.”
As for the FOMC minutes, HSBC said that a weak jobs report and decline in consumer confidence since the last policy meeting should have mitigated any damage to gold.
“It may be the case, however, that investors believe that the economy is entering a more normal phase,” HSBC said. “Even if the economy cannot be described as performing well, it appears to be past the crisis period of recent years. The reduction in the possibility of a ‘tail risk event’ may be undercutting safe-haven demand for gold.”
As for the shift away from commodities, HSBC pointed out silver has fallen even more than gold on the sell-off. Further, oil and copper are down 9 per cent and 14 per cent, respectively, since mid-February. By contrast, the S&P 500 is up over 10 per cent so far this year.
Meanwhile, gold ETF appetite had been an ingredient in gold’s rally since 2004, but there have been net outflows this year.
“Although we believe the bulk of ETF investors including pension funds, real asset managers and high net worth retail individuals have a ‘buy and hold’ trading strategy, it is clear that hedge fund liquidation has noticeably reduced ETF holdings,” HSBC said. “Given the size of the ETFs, the potential for further liquidation exists. Should liquidation continue, we believe it is likely to be from macro hedge funds. Hedge fund liquidation is fast whilst real economy buying is slow.”
The possibility of Cyprus selling gold, as was reported last week, raises worries about even greater central-bank selling, HSBC said. However, analysts said their view is that even if Cyprus does sell, other central banks will not follow suit. “In any case, these countries are party to the Central Bank Gold Agreement which limits central bank gold sales,” HSBC said.
Meanwhile, HSBC listed several factors on why it looks for prices to stabilize, starting with increased demand for jewellery, particularly in price-sensitive emerging markets.
Similarly, retail investment demand should benefit, HSBC said. “Coin sales tend to drop when prices rise sharply and recover on price declines, as many retail buyers take lower prices as a buying opportunity.”
Mine expansion plans at the top end of the cost of production are likely to be curtailed, the bank said. Reduced supplies for any commodity are supportive for prices. Further, merchants may hoard scrap after the price decline, HSBC said.
“These real factors take time to work into prices, however,” HSBC said. “Hedge fund sales are fast and large. We believe that the robust gold bull rally of the past 12 years is probably over. It may take a long time for investor confidence to return. But we do believe gold is becoming oversold and that tighter supply/demand fundamentals and a still positive macroeconomic background will eventually lead to a steady grind higher.”
HSBC said it still believes gold is an attractive investment for portfolio diversification and as a hedge against certain inflationary scenarios.
“Despite this fall, we would not write off gold as an important part of an overall asset portfolio,” HSBC said. “We maintain an 8 per cent tactical gold position in our asset allocation.”