Gold is down $37/oz. What's happening?
People have been taken aback by today's sharp decline in precious metals, and even sharper decline in mining shares. For months, it's seemed, gold has risen relentlessly, regardless of the activities of the broader market. Today, it seems, the pattern has changed.
What has gold been doing recently? Since last fall, it started an unusual correlation to the US$ index, in which both gold and the US Dollar would rise and fall together. The dollar index was a good thing to get hitched to, the dollar is up almost 20% since Thanksgiving of 2009 and this surge has carried gold to a new all-time high. The thinking has been that the flight into the US Dollar (and Japanese Yen, and Swiss Franc, and US Treasuries) and gold was a flight to safety. People were fleeing the bankrupt European states and taking shelter in the less sickly US and Japanese economies. They also sought out gold and (to a lesser extent) other commodities.
I'm convinced this was right to some degree. I predicted a dollar rally last year to at least 85 on the dollar index. Even I was surprised, however, when we went up for a challenge against a long-standing top at 89. We failed, but the fact we got that far in the first place said there was more than an expected amount of dollar strength. But why?
It seems that perhaps hedge funds and other power players loaded up on leveraged dollar and precious metals positions. As the rally in gold and the dollar has continued, they've become ever more correlated, to the point that the two often trade nearly identically now. When large margin calls (or something) were unleashed last night and the dollar fell 3 cents against the Euro (the biggest move in awhile), it's only natural that the same margin calls also rocked the precious metals world. The fast-moving hedge funds who gorged themselves on dollars, gold and other "safer" assets ... often as a hedge for their declining US equity positions ... were forced to unload. Thus the harrowing decline in the dollar, gold, and miners today. Many junior miners are down 8 or more percent, and this is on top of steep declines in the past few days. While a lot of these miners that are getting killed (Nadagold, Seabridge, Allied Nevada and others deserve their loses), there's some genuine bargains starting to emerge.
That said, as long as the hedge funds remain overlevered and are long commodities with hot money, expect gold to take further losses. They will unload the assets that are showing gains (US dollars and precious metals) rather than the ones showing losses (mortgage equities, real estate, US equities, European debt, etc.) Live by the hot money, die by the hot money.
When the US$ index and gold decouple, we'll know the hot money has moved on to a different trade. But for now, be cautious. We're at an interesting crossroad in gold and mining shares.