Gold: Bullish Case Still Intact

Despite the first US government shutdown in 17 years, gold prices came under heavy selling pressure on October 1, as gold for December delivery sank 3% reaching a lowest level since August 8.

How can this sell-off be interpreted?

As a matter of fact, we are seeing a lack of safe-haven demand in the short term as investors are expecting a limited government shutdown. That is why we are seeing today gains in US equities. Moreover, traders seem to prefer getting liquid and gold is seen as a source of cash. Finally, the other reasons why gold is going down today is mainly due to trading drama:

1. Strong technical pressures. From a technical perspective, the $1,300 level is a very strong psychological support as I wrote here in my previous article. Given that gold broke this level, it triggered many sell stops, exacerbating the decline.
2. Forced liquidation. According to Brendan Conway, Andrew Wilkinson of Miller Tabak told clients he’s heard from a London contact a “major U.S. fund” is rebalancing its gold position on the first day of the third quarter of 2013. Jonathan Jossen, a Comex gold options floor trader added that “it’s obvious it has to be a fund that is just now forced into liquidation”. Finally, Axel Merk, a portfolio manager at Merk Funds said that “somebody put in a big sell order”. Even though this is not confirmed yet, as volume was heavy amid the sell-off, this scenario is very likely.

(click to enlarge)

Source: Stockcharts

The bullish case remains intact.

From a historical perspective, it could be interesting to examine the gold market during the last US government shutdown (December 16, 1995-January 6, 1996).

Source: Kitco

As seen above, gold prices fell down by about 1% the week before the US government shutdown before rising by a whopping 2.5% from $386.50 in December 16, 1995 to $396.20 in January 6, 1996 as investors were looking to protect their portfolios.

Today, we are surprisingly seeing a sell-off in the gold market, which means that investors hope for a limited US government shutdown. Nonetheless, the next 17 days should be very interesting for the gold market as October 17 is the debt ceiling deadline. Investors need to know that hitting the debt ceiling is so much worse than a government shutdown.

As a reminder, gold rose by a whopping 18% in August/September 2011 during the US debt ceiling debate as an agreement was reached only at the last minute, pushing gold to an all-time high of $1,920 an ounce vs 2.5% in December 95/January 96 during the US government shutdown.

With what happened today, US politicians seem not to realize the impact on the financial markets if no agreement is reached. Consequently, the odds of the debt ceiling not being raised are increasing.

To sum up, it is fair to say that a looming US debt ceiling fight will eventually undermine investor confidence and demand for safe-haven assets including gold are likely to surge until a deal is reached.

This bullish scenario remains intact given the recent developments in the options market. Indeed, according to Harriet Hunnable, Managing Director Metals of CME Group, she has seen a lot of activity in options on the exchange. She also said that the market is at a pivotal point and traders expect sharp swings in precious metals prices. Last but not least, she said that last week more traders bought call options in gold, which means that they seemed to be more optimistic about gold’s future value.

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