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Gold's Goldman Drop Blamed on Strong Correlations, Chinese Whispers & ETF Exposure

Commodities / Gold and Silver 2010 Apr 19, 2010 - 09:27 AM GMT

By: Adrian_Ash

Commodities

Best Financial Markets Analysis ArticleTHE PRICE OF GOLD bounced from a new two-week low for US investors early in London on Monday, rising 0.7% from beneath $1125 an ounce as silver, energy prices and world stock markets also extended Friday's sharp losses.

Crude oil fell towards $81 per barrel, while the Euro tracked gold vs. the Dollar, and the Dollar itself hit a 4-week low vs. the Japanese Yen.


Following Friday's news that investment bank Goldman Sachs is being sued by US regulators for fraud, "Precious metals were unable to avoid the liquidation," in the words of one London dealer.

"As risk sentiment plunged, investors shifted from equities and commodities into US Treasuries," says HSBC in a note, and "Gold is clearly sensitive to changes in investor risk sentiment."

"Ultimately, we're looking at a pull back in risk," says a currency analyst. Gold prices had just "hit high correlation [with stocks and commodities] but now risk is off."

"In an interesting manifestation of the 'Chinese-whisper effect'," says long-time gold advocate Martin Hutchinson at Money Morning, "a frantic 'Sell Goldman' call obviously got transmuted into 'Sell Gold'."

Goldman Sachs' stock lost more than 12% on Friday, falling to a 7-week low.

However, the Paulson & Co. hedge fund – named but not charged in the SEC's accusations against Goldman Sachs – is also the single largest investor in the SPDR Gold Trust (GLD), controlling some 8.4% of the securitized gold ETF fund according to end-2009 filings.

Worth some $3.5 billion at current prices, Paulson's GLD position compares with the $1bn apparently made after helping to select and then betting against subprime mortgage-backed bonds sold by Goldman Sachs to other institutional investors.

Concerns over the "massive build-up of investment stocks" in exchange-traded funds were most recently raised by the GFMS consultancy at its Gold Survey launch here in London last week.

Holdings at the SPDR gold ETF ended Friday unchanged for the week, standing at a record 1141 tonnes of bullion.

If fraud were proved against Goldman Sachs, notes the Financial Times' Alpha blog, "then John Paulson's hedge fund will be braced for compensatory claims."

But "Everyone in the market knew that portfolio agents [creating a package of different mortgage-backed bonds] would be lobbied both by long and short sides," notes John Gapper in the main FT paper today.

Bullish investors buying the resulting product effectively offered to pay the bears if the bonds defaulted, earning what was akin to an insurance premium in the meantime.

"The evidence that Goldman actively misled [German bank] IKB and [debt investor] ACA Capital about the transaction, as opposed to not disclosing everything, is patchy. There is no 'smoking gun' e-mail."

What's more, Goldman Sachs said Friday that it lost $90m on the deal itself – even after accounting for the $15m fee it received from Paulson & Co. for creating the disputed product – by investing in the collateralized debt obligations it sold to IKB.

The German bank, apparently "among the most sophisticated mortgage investors in the world" according to Goldman Sachs, received almost €10 billion in emergency government aid after nearly collapsing in late 2007.

"[Friday's drop was] a good thing from the point of view of continuing this rally" in global equities, reckons James Paulsen, chief investment strategist at Wells Capital Management, speaking to CNBC.

"I really think this market was stretched. You had a heck of a move in 45 days. It's a refreshing pause."

Ahead of Friday's 2.5% sell-off in gold prices, speculative players had raised their bullish betting on Comex gold futures and options for the third week running, latest figures from US regulator the CFTC show.

The "net long" position of bullish minus bearish bets held by hedge funds, private investors and other non-industry traders rose by almost one-third from the start of April to last Tuesday evening – the fastest fortnightly pace since Sept. 2009 – to hit a 3-month high equal to 909 tonnes of gold.

Precious metals dealing in Asia today "was disappointingly slow" says one Hong Kong broker, "despite the substantially lower prices" in gold, silver, platinum and palladium.

The silver price meantime hit a new April low of $17.48 an ounce, extending Friday's "collapse" below what technical analysts at bullion bank Scotia Mocatta call "massive technical support" at $17.66.

"While the Goldman Sachs saga has been the main factor" driving prices, says Leon Westgate at Standard Bank today, "geology has also been an issue [because] gold is often transported using commercial airlines.

"With flights in much of northern Europe still banned, due to the volcanic eruption in Iceland, there are concerns over the availability and movement of physical gold...impacting premiums in other parts of the world."

Trade association the London Bullion Market Association told Bloomberg that its members haven't yet encountered any problems securing supplies.

"With physical hubs dependent on air freight from London and Zurich – and in tandem with local metal stocks running thin – [the Icelandic eruption] could lead to local prices trading sharply into premium territory" outside Europe, reckons UBS strategist Edel Tully.

By Adrian Ash
BullionVault.com

Gold price chart, no delay | Free Report: 5 Myths of the Gold Market
Formerly City correspondent for The Daily Reckoning in London and a regular contributor to MoneyWeek magazine, Adrian Ash is the editor of Gold News and head of research at www.BullionVault.com , giving you direct access to investment gold, vaulted in Zurich , on $3 spreads and 0.8% dealing fees.

(c) BullionVault 2010

Please Note: This article is to inform your thinking, not lead it. Only you can decide the best place for your money, and any decision you make will put your money at risk. Information or data included here may have already been overtaken by events – and must be verified elsewhere – should you choose to act on it.


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