Precious Metals Bloodbath... Why?

Fear of an economic slowdown caused by the coronavirus triggered a stock market crash on Friday that spread to the precious metals markets. According to textbook theory, when equities fall, safe-haven precious metals — especially gold — should rise. Yet that is not what happened. Why?

In the last trading week of February, market sentiment shifted. Investors are no longer pricing in a brief, few-week slowdown, but a recession potentially arriving this very year.

The catastrophic Chinese car sales figures (a decline of 80–90% in February) make it easy to understand why the two catalyst metals — palladium and platinum — fell so sharply, and the economic slowdown also provides grounds for a price correction in silver, which has a semi-industrial character. But what explains the unusually steep drop in gold?

LOOKING AT GOLD'S ONE-YEAR PRICE CHART

Since the end of May last year it has been clear that the US Federal Reserve will not tighten monetary policy or raise interest rates; quite the opposite — it will pump further liquidity into the economy (effectively printing money). This caused the first major price rally from June to September 2019, from $1,290 to $1,560 per ounce. The subsequent consolidation coincided with stock market optimism, and gold drifted down from $1,560 to $1,450 between September and early December 2019. After that, the Iranian situation and then coronavirus fears pushed the price close to $1,700 by 24 February 2020. Last week the stock market decline accelerated and turned into a panic, dragging the gold price down with it.

HOW DID GOLD BEHAVE DURING AND AFTER THE 2008–2009 FINANCIAL CRISIS?

The 2008 financial crisis actually began with the collapse of investment bank Bear Stearns in March 2008 (which coincided almost exactly with gold's local peak of $1,030 per ounce), but it only became apparent to the whole world in September 2008 with the bankruptcy of Lehman Brothers. The panic triggered by the Lehman collapse spilled over into a global liquidity crisis in which banks were unwilling to lend to one another and everyone suddenly needed dollar account money and cash. Markets seized up; many assets could not be sold at all. Physical gold, however, still found buyers — albeit at ever-lower prices, as excess supply continually dragged down the price. The Fed injected $630 billion into the international banking system at the end of September and early October 2009, and governments announced bank bailout plans one after another, which ultimately prevented a complete collapse.

By that point, however, gold had already fallen to around $680, some 34% below its spring peak. From there, a three-year rally followed with an 280% price increase, culminating in the still-unbroken September 2011 high of $1,910 per ounce.

WHAT CAN WE EXPECT FROM THE GOLD PRICE NOW?

What distinguishes the current gold price decline from that of 2008 is that no liquidity crisis has emerged this time, and one is not expected in the near future. The gold correction seen in the last week of February 2020 was driven primarily by the fact that, as fears rose, speculators sought to hold smaller positions — closing leveraged and credit-financed positions and, along with them, trades in which they could still book a profit and that were easy to sell. Gold positions were typically among these, since virtually everyone was sitting on a healthy gain and therefore moved to close them, creating a sudden glut in the exchange-traded gold market. The physical gold market responds more slowly; we have not really witnessed such reactions there.

_Since our previous gold price article_, _the price has reached both the upside and the downside targets we mentioned. We are watching with interest to see whether, after the brief sideways movement typical of such situations, the market can resume its upward trajectory._

In our view, a correction of the same magnitude as 2008–2009 is not to be expected in the gold price at present. The coronavirus-induced stock market panic is unlikely to cause a financial crisis on the scale of the 2008 mortgage crisis, and so the approximately 8% correction seen last week may well be sufficient to allow the gold bull market to continue. The ultimate target of the current bull trend is, without question, the prospect of breaking the 2011 price peak.