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Gold’s Crash: A Conspiracy?

The epic collapse of gold in the middle of April made a lot of headlines. But since then, the story has changed a bit.

First, there’s the fact that gold is up about 10% from its low of $1,322 to around $1,450, and some of the bearish folks are starting to take profits and call a floor after the recent rout.

And secondly, it’s becoming increasingly common to hear talk about how the recent crash in gold wasn’t actually due to normal market action at all. Those catching the blame in the blogosphere include obvious culprits like the Fed, but also high-frequency trading robots.

So was this crash driven by fundamentals, or by speculators or a conspiracy?

Here are some arguments bandied about by goldbugs:

Gold Lease Rate: A certain group of gold investors — namely, central banks — pay to borrow gold. And recently, there has been a correlation between the lease rate and the nominal price of gold. But as Charts Inc. notes, that correlation simply wasn’t there in the latest contraction.

leaserate

“Paper” Gold: Some gold watchers claim that “naked short selling” remains rampant. Speculators — or if you believe some goldbugs, the Fed or the ECB — were selling gold they never arranged to borrow in the first place. Similar claims were made about vulture investors shorting stocks during the financial crisis.

A “Golden Swan” Event: This was a once-in-a-2-million-years event. And though painful, it’s not necessarily anything that means the end of the world — or the end for gold.

On the other hand … bears say the downturn in prices was very much justified and point to these factors:

Mean Reversion: As Lance Roberts of Street Talk Live puts it, “The current correction is well within the normalcy of extreme price movements” and was due for a slip after deviating so far from its norm.

Golddeviation

GLD Redemptions: The problem with gold being securitized and exchange-traded via SPDR Gold Shares (NYSE:GLD) and iShares Gold Trust (NYSE:IAU) is that both buyers and sellers have ease of access. The reason gold went parabolic in the past decade is partially because of fear and macro issues, but also because it was easier than ever before to buy in … so once the bloom is off the golden rose, the ease to panic-sell is equally accessible. And when people start selling gold because it’s falling, it causes the metal to fall, which prompts more sales — something called “cascading risk.”

Paulson, Unwound: What happens when a hedgie finds himself $1.5 billion in the hole and needs to unwind a trade that’s going the wrong way? Ask John Paulson about gold if you see him, and he’ll probably say that it results in a big sucking sound for the rest of the market.

There are obviously many factors at play with gold and commodity pricing, including the strong dollar, geopolitics and investor psychology. None of these aforementioned items is the magic bullet for gold pricing.

But it’s worth noting all sides of the trade right now, as gold fights back from its lows but has an uncertain future.

Related Reading

  • The gold lease rate correlation is also BS if you believe some analysts. (Pragmatic Capitalism)
  • Paul Craig Roberts blames government manipulation on the gold decline. (PaulCraigRoberts.org)
  • Mathew Lynn argues that now is the time to be bullish on gold. (MarketWatch)
  • Yves Smith says, “Trading mavens like to say that violent downturns lead to dramatic retraces, but that would likely be followed by further declines.” (Naked Capitalism)

Jeff Reeves is the editor of InvestorPlace.com and the author of “The Frugal Investor’s Guide to Finding Great Stocks.” Write him at editor@investorplace.com or follow him on Twitter via @JeffReevesIP. As of this writing, he did not own a position in any of the stocks named here.

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