Gold Sell-off as Fiscal Cliff Deadline Approaches

Gold fell 1 percent on the final day of November trading, posting its second consecutive monthly decline. As the standoff in Washington continued, weakness in the gold market intensified. On December 4, gold fell below $1,700 to a four-week low of $1,686.

“[C]racks in investor confidence … [have] widened,” Standard Bank said on Monday. Noting that the futures market has turned on gold, the bank also said selling pressure was “clearly evident as markets were weighed down by fiscal cliff concerns.”

“Underlying the net deterioration [of speculative length in COMEX gold futures] were the most bearish moves we’ve seen in gold for some time,” the firm added.

For many, it is likely odd to hear words such as “bearish” and “selling” given the circumstances. It was widely expected that US lawmakers’ failure to reach a deal would be bullish for gold. However, the current circumstances provide an example of an expected cause-and-effect relationship that simply did not transpire, according to INTL FCStone.

“We thought that gold would rally substantially as the talks were going on, but then sell off once an agreement was reached; this proved not to be the case … as we are now in the midst of a substantial sell-off in the precious metal before any substantive talks have even gotten underway,” the firm said in recent commentary.

Gold sell-off in perspective

The selling of gold is not readily occurring in all camps. Gold ETFs are not only holding up, but are also seeing investor buying. Standard Bank reported a seventh consecutive week of increases, which brings holdings to another record high of 2,717.7 metric tons.

Bullion investors are displaying a hearty appetite for gold and American Eagle sales reportedly tripled last month, with 131,000 sold compared to 41,000 last year.

“The fiscal cliff is causing a huge stir in investment markets, and this is precisely why gold coin sales skyrocketed in November,” said Arthur McGuire, vice president of Gold Coin.

The bulk of recent selling is believed to lie in the camp of managed money.

Commerzbank said the significant reduction in net-long positions by speculators shows that the recent slump in gold prices was brought on by money managers selling.

“Not only were long positions reduced; at the same time, short positions were increased to a 15-week high. The adjustment process should now be virtually complete, so the pressure on prices from this side should abate,” the firm said.

Seasoned market participants are likely acquainted with some fund managers’ tendency to sell successful assets before year end to lock in profits or access liquidity. However, this year, the impending fiscal cliff is serving as an additional incentive due to the risk of higher taxes.

“There is a significant amount of industry selling in anticipation of higher taxes related to the fiscal cliff,” Frank McGhee, head precious metals trader at Integrated Brokerage Services, told Reuters. “On the other hand, there is a fair amount of retail buying, but in this case Wall Street tends to win,” he added.

Morgan Stanley is not so sure that hedge fund redemptions and year-end book squaring are done. The firm said there is a possibility that the trend will continue for the remainder of the year, and thus could keep weighing on gold prices. But the firm also said, “we believe that gold will resume upward momentum in 2013, as the underlying fundamentals that helped deliver a record annual average price in 2012 remain in place.”

Gold fundamentals to change in 2013?

US economic conditions, the Fed’s monetary policies and interest rates are key factors for gold. Last week, Goldman Sachs (NYSE:GS) created quite a buzz with its prediction that these fundamentals may change next year.

“Near term, the combination of more easing and weaker growth should prove supportive to gold prices. Medium term however, the gold outlook is caught between the opposing forces of more Fed easing and a a gradual increase in US real rates on better US economic growth. Our expanded modeling suggests that the improving US growth outlook will outweigh further Fed balance sheet expansion and that the cycle in gold prices will likely turn in 2013.”

The firm lowered its three-, six- and 12-month gold price forecasts to $1,825, $1,805 and $1,800 respectively, while forecasting an annual price of $1,750 in 2014.

Responses came swiftly, with some market participants disagreeing and some deeming Goldman’s call bearish and premature. However, some of those same points are being made by others.

BNP Paribas (EPA:BNP) also lowered its outlook for gold, stating that it now expects the metal to average $1,865 in 2013 and $1,780 in 2014.

Citing expectations that the metal will hit a new record next year, the firm’s analyst, Anne Laure-Tremblay, said that once gold peaks in 2013, its price is expected to enter a period of gradual decline as the market begins to anticipate the withdrawal of monetary easing measures in line with improving economic growth.

“While a recovery in US growth in 2013 may cause real interest rates to rise and add headwinds to gold price performance, there are enough supporting factors to indicate relatively limited gold price downside. Meanwhile, there are many potential upside tail risks,” said ETF Securities.

Securities Disclosure: I, Michelle Smith, do not hold equity interests in any of the companies mentioned in this article.