Gold traders need to tread with caution

Philip Salter
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EUROPE’S central banks are back on the yellow metal, after two decades of shunning the barbarous relic. They are late to the table – traders have been making money going long on gold for years. There are still profits to be made, but in volatile markets timing is everything. Leveraged traders will have to act nimbly, as yesterday’s dip showed.

Central banks in Europe are, on aggregate, now net buyers of gold, following two decades of selling it against its long-term bull trend. This extra 25,000 ounces of gold sitting in the vaults of Europe’s central banks isn’t moving markets, but it’s crucial for showing changing sentiments. For Europe’s central bankers, buying gold is a hedge against their own inability to solve the Eurozone crisis – it’s a wonder it took them so long to put on the bet.

Yesterday gold dropped $59 from a high of $1,828/oz to a low of $1,770, but we are still in a bull market. Michael Hewson of CMC Markets says even a collapse to $1,600 wouldn’t change this, while David Jones of IG Markets says it would take “a slide though $1,500 to even start suggesting this trend was in trouble.”

One question troubling many traders is why gold didn’t go stratospheric following the Swiss National Bank’s intervention to keep the Swiss franc below €1.20. Ian O’Sullivan of Spread Co thinks “some of the violent falls in gold may be related to hedge funds and investment houses having to liquidate long gold positions to fund margin calls and losses on Swiss franc bets.” Carl Astorri, global head of economics and asset strategy at Coutts, notes “lots of funds have been trading the positive correlation between Swiss franc and gold, which is based on the near 70 per cent backing of the Swissie by gold.” As such, “when the central bank started to intervene and push down the Swissie,” Astorri says, “correlation models assumed gold would fall as well.” However, Hewson thinks gold didn’t take off because of fears that the margins on gold would be raised. The Chicago Mercantile Exchange (CME) has recently tripped up traders twice by raising the requirements on gold futures.

Angus Campbell of London Capital Group is also bullish on gold, noting that it remains well supported – adjusted for inflation it is still nowhere near its nominal high hit back in the 1980s – with many traders expecting it to hit the targeting $2,400. However, Campbell also points out “even though the longer term uptrend might still be intact, any long position could be subject to a costly correction to the downside, even if it is a small one in percentage terms.”

Yesterday’s pullback is illustrative of the volatility risks and the usefulness of charts. Campbell noted the formation of a double-top on yesterday’s daily chart, prior to the dip.

Despite these risks, traders taking due attention to short-term trends and lucky enough to avoid any changes to the margin requirements on gold futures, could profit by buying in after the dips – the fundamentals of global debt still point strongly to a continued bull market.