In last week’s report, I addressed the possibility of slight corrections for gold and silver prices. They had recently risen almost exponentially in the run-up to the end of the month. The events of last Friday and this week Monday, however, I could not have imagined in my worst nightmares. Even long-time observers of the precious metals markets are unlikely to ever have experienced a setback of this magnitude.
Price slumps across precious metals markets
From last Thursday evening to Monday evening, gold prices had dropped by around 13.3 percent within two trading days – the sharpest two-day decline since 2013 and the second largest since the 1980s, after having somewhat recovered from their lows on Monday morning. Silver also came under massive pressure, suffering a historic two-day slump of 31.5 percent. This movement marks the greatest two-day loss since the start of recording daily data by Bloomberg in 1950.
Various media have cited US President Trump’s nomination of Kevin Warsh as the new chairman of the Fed as the trigger for a recovery of the US dollar. During his first term at the Fed under Ben Bernanke, Warsh had been a proponent of a more restrictive monetary policy and higher key interest rates. I, however, see two further reasons which may have been even more significant:
Selling pressure due to increased CME margins for gold and silver
The history of the financial markets teaches us that short and at times sharp price corrections usually occur when the prices of an asset rise too quickly over a short period without correction. It is also a fact that spectacular price rallies often attract the attention of stock exchange operators. Over the weekend, a US futures exchange announced its requirement of higher collateral for precious metals. Margins were raised from 6 to 8 percent for gold and from 11 to 15 percent for silver. The decision increases capital requirements and can cause short-term, speculative investors to close their positions; in the current case, their long positions.
The second important factor is the options markets. Where there is a buyer, there is also a seller of an option. Put simply, this means that if the price of gold rises, the seller must buy more on the market, but if the price falls, the seller must sell gold. If prices fall quickly and sharply, there is often no other choice than to sell, regardless of the current price.
Gold intermittently falls below 5,000 US$ per ounce
The first warning signal: while gold remained close to the record high of 5,595 US$ per ounce last Thursday morning, i.e. at 5,515, it slipped to 5,210 on Thursday afternoon. Following its recovery to 5,450 by Friday morning, it dropped further to 4,895 at the end of the week. The slump continued at the start of trading on Monday morning, kicking off the week at 7:30 with the day’s low at 4,403 before nearly regaining the mark of 5,000 US$ per ounce on Tuesday and recovering further to 5,090 today. At the time of writing on Wednesday 4 February at 2:30 p.m., gold is trading at 5,050 US$ per ounce.
Xetra-Gold at weekly low of 125 € per gram
The Xetra-Gold price deteriorated similarly amid strong volatility, rising from 148.75 € per gram last Thursday morning to a new record high of 149.10 intraday. By the end of the week, it had already fallen to 134.50, and on Monday, it hit a weekly low of 125.00, followed by a recovery to 138.30. At the time of writing this report, Xetra-Gold stood at roughly 137 € per gram.
End of the rally?
Overall, the reasons which led investors to gold are unlikely to disappear overnight (geopolitical uncertainties, a desire for greater diversification). Over the coming days, the markets will show to what extent investors are increasing their caution with regard to buying gold. Data suggests that many viewed the sharp decline as a buying opportunity, be it physically or in the form of ETCs. The Chinese New Year celebrations the week after next could result in a noticeable short-term decline in demand from China.
I wish all readers strong nerves and an improved meteorological situation. Please note that the next market commentary will be published the week after next.