The falling gold price is making money for traders around the world, writes Belinda Beresford
Champagne corks were popping in New York this week as traders celebrated their winning bets that the gold price would fall. Meanwhile, on the other side of the Atlantic in Pretoria, miners demonstrated in a desperate attempt to draw international attention to the human effects of a drop in the value of bullion.
Yet again, South Africa’s economy is being hammered by speculators, only this time they are betting on a fall in the gold price, rather than a drop in the rand.
Speculators and investors have been “shorting gold” – selling gold they do not have for delivery at a future date in anticipation that the price will fall. If it does so, they will then buy the gold for a lower price, sell it at the pre- negotiated price, and pocket the difference. Of course, if the price rises, they lose out. The converse position is to trade long, and bet that the gold price will rise.
Conspiracy rumours abound about the activities of the Bank of England and the persistent fall in the gold price. Last month a British MP reportedly tabled a question in Parliament questioning whether the government’s actions had been designed to push down the gold price to help British gold traders who had taken short positions on the yellow metal.
This week, a Canadian newspaper reported that John Willson, head of Canadian gold- mining company Placer Dome, had written to British Prime Minister Tony Blair about the issue. The Globe and Mail reported that the letter, also written on behalf of five other gold producers including AngloGold and Gold Fields, quoted the parliamentary question.
In an interview, Willson reportedly said: “I don’t think there’s any kind of major conspiracy, but the rumour is there.”
Fuelling such rumours is uncertainty about why the Bank of England would choose to announce gold auctions in such a manner in a negative market. The Chamber of Mines has calculated that the British government has hardly done well out of the sell-off. The Chamber’s economist, Roger Baxter, says the drop in the gold price in anticipation of international sales had cost the British government about $700-million.
What is certain, however, is that central bank behaviour and speculators are largely responsible for the consistent attack on the gold price. The current environment encourages traders to bet short – that the price will fall – rather than to bet long – that it will rise.
As traders bet against gold, it encourages negative sentiment towards the metal, which creates a vicious cycle. In addition, as the gold price falls, it triggers sales from technical traders – investors whose decisions to sell or buy are made almost solely by the price level of an investment. It was these kinds of pressures on sterling that contributed to driving Britain out of the European exchange-rate mechanism.
A precious-metals analyst at Wall Street firm Pell Brothers was reported as saying that “there doesn’t seem to be any reason to buy gold unless you go short”. Don Tierney also said that traders would be packing bars to celebrate their gains at the end of trading from the gold price hitting new lows.
Markets are expecting central banks and the International Monetary Fund (IMF) to sell gold: if gold is sold, supply increases and the price should therefore go down. The fact that according to the World Gold Council demand for gold is still outstripping supply, despite anticipated sales, has not so far had much of a braking effect on this negative market sentiment.
“There is no doubt that speculation about official gold holdings has been the major reason behind the decline in price,” said Baxter.
He pointed out that central banks only hold about 25% of above-ground stocks of gold and that only six major central banks were engaged in gold sales. However, “fear has driven perception”, Baxter said.
Fleming Martin gold analyst Brenton Saunders says speculation has led to record short positions on gold with about 8,5- million ounces of gold known to be involved in such transactions on America’s main gold market, the Commodities Exchange in Chicago. Yet the amounts involved are probably far higher since most gold trading takes place on other, less well monitored exchanges, Saunders said.
Speculators in gold don’t actually have to buy the metal – they can lease it from central banks through so-called bullion banks for a “lease price”.
The bullion banks can take the money they are paid for lending on the gold and invest it elsewhere at higher returns – this difference is called “the contango”.
In a market filled with negative sentiment, the increasing willingness of central bankers to lend out gold has been pushing down the lease price. Saunders expects the gold price to continue under pressure as long as central banks are increasingly willing to lend out gold at low lease rates.
“Unless you see a combined effort of central banks making a conscious decision to tighten supply and increase lease rates, the price will continue to come under pressure,” Saunders said.
Central banks are selling gold as part of a restructuring of their asset portfolios. They are moving away from the historic safety of gold, a commodity you can see and touch, to put their faith in modern financial instruments. The money locked up in gold can be invested in financial markets, earning a higher income return.
This trend has been unsettling the markets for a while, but it is exacerbated by the suggestion that the IMF sell its gold reserves and use the proceeds to write off the international debts of highly impoverished countries.
But many developing countries are gold- producers, or are linked to countries that are. These countries will suffer job losses and political and economic instability, just as South Africa is beginning to suffer.