March 12 2007

Carried Away

Ok, then.  So much for the February highs holding on the gold market, as we’d hoped.   Last weeks action in bullion surely needs no introduction to traders, since the gold chart looks pretty much like every other chart out there namely, down, down and more down; and then back up.  While we’re not happy about the way gold (or much else) traded last week we were more surprised about the reaction to its trading by many long time supporters.

We find it ironic that many of gold staunchest supporters and a number of general market commentators that listen to them read all sorts of economic calamity into the pull back in gold prices during the market pullback.  Gold bugs have been lobbying for years to have the yellow metal treated as an important asset class in its own right.  Well, welcome to being a recognized asset class. 

Many gold followers find it incomprehensible that that major indices and gold could fall at the same time.   Gold is the safe haven so the nastier the economy looked the stronger and longer the up leg in gold prices would have to be, right?

Nope.  Gold has attracted enough attention that it’s been used as one side of any number of “currency pair” or “carry” transactions.    When traders smell risk and start unwinding their high leverage trades (and carry trades are some of the most leveraged) they have to close out both sides of the trade.  As it happens, there were clearly some carry traders in the gold market, probably for the simple reason that it was one of the stronger sectors last month and attracted momentum chasers.  When the combination of weak US stats and a 25 basis point increase in the Bank of Japan overnight rate combined to put a scare into trades gold got sold along with everything else that was part of the carry’s. 

That action seemed clear to us, with almost all of the down leg coming in two separate sharp sell offs.  The first on in particular had the mark of either an inexperienced gold trader or someone who had margin call that simply would not wait.  A large sell into the slowest part of the trading day on the electronic market dropped the price by $22 in a matter of minutes.  Not a lot of fun to watch but the very stupidity of the trade made it less concerning. 

All of us who see a strong future for the yellow metal should expect days like that.  In order for the gold price to climb to levels that gold bugs dream of, the market by necessity has to broaden considerably.  Many of the new entries will be trading for their own reasons, be using gold and a part of seemingly unrelated transaction or just be the infamous “dumb money”.  And many will treat it like just another asset class.  That means it will sometimes get sold along with everything else in some of the fear induced pull backs every bull market has.

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David Coffin and Eric Coffin are the editors of the HRA Journal, HRA Dispatch and HRA Special Delivery publications focused on metals exploration, development and production stocks. They were among the first to draw attention to the current commodities super cycle and have generated one of the best track records in the business thanks to decades of experience and contacts throughout the industry that help them get the story to their readers first. Please visit their website at www.hardrockanalyst.com for more information.

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