The gold rotation

Big investors might not be rotating out of fixed-income yet, but a similar dynamic could be encouraging a shift out of gold and other commodities.

Gold’s collapse on Monday took prices back to where they were two years ago, representing a 15% sell-off from Friday’s high. There are plenty of theories going around to explain this, but one of the more interesting is a re-take on the Great Rotation.

Barry Ritholtz, who runs online quantitative research firm Fusion IQ, noted last week that the rotation out of bonds has not happened yet, but that there might be another kind of sector shift going on that could help to explain the recent weakness in gold and other commodities.

Many of the institutions that loaded up on illiquid and esoteric assets during the 2000s now have a new generation of managers who would like to offload these positions and move into more liquid assets, but most of this legacy stuff is too costly to get out of.

“One of the few that is not [is] the commodities/managed futures bucket,” he writes. “My guess, based on prices and logic, is that these new managers are selling what they can — and that is commodities.”

This doesn’t explain the speed or scale of the crash, which was possibly triggered by Cyprus's announced gold sale, and there are certainly other contributors to the overall shift in sentiment. Societe Generale made a bearish call on gold at the start of April with a warning that the market was in “bubble territory” and had the potential for a 20% to 30% crash.

SocGen rated this as “not terribly likely”, but identified several macro trends that were weighing on gold generally, including subsiding inflation fears, an improving economic outlook and a stronger dollar.

“It seems unlikely that investors would want to add much to their long gold positions in this context,” said the report. “If so, the gold price would trend lower at pace as the physical gold market is seriously oversupplied without continued large-scale investor buying. Selling by investors would add fuel to the fire.”

Even so, SocGen was expecting it to take all year for gold to lose 15%, with the Bloomberg consensus predicting at the time that gold would end the year at $1,752.

Bank of America Merrill Lynch was one of the most bullish, with a price target of $2,000 for 2014. It removed that yesterday, citing “a breakdown in fundamental and technical support for gold in the coming months”, led by disinflationary trends.

However, BoA Merrill is still looking on the bright side, arguing that jewellery demand alone could support prices at more than $1,500 through 2016 even if institutions remain net sellers.

“Looking at sensitivities from a different angle, investors would need to buy merely 600 tonnes of gold to sustain prices at $2,000 an ounce by 2016, compared to non-commercial purchases of 1,798 tonnes in 2012,” it wrote.

In the short term, BoA Merrill reckons rock bottom is around $1,200. There was certainly plenty of gold buying going on in Hong Kong yesterday, as well as reports of similar demand in China and India. Big investors in the US might have stopped worrying about inflation, but Asian buyers are clearly not there yet.

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