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Trauma Produces Split Personality in Gold Market

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Does this spontaneous mass mom-and-pop affirmation of gold's value matter compared to the bearish calculations of investment bank and hedge fund experts? Actually it does.

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Suppose you had your house on sale and were finding no takers. You cut the price by 10% or 15%, and the next morning find buyers lined up around the block. You might think you had found the right price for the asset, or overshot a bit on the downside.

A similar situation persists on the world gold market after the metal's worst week in memory – sort of. Gold's value as measured by the popular SPDR Gold Shares ETF (NYSEARCA:GLD), plunged 13% from April 11-15 before rebounding slightly later in the week. The metal's value has dropped 22% from a high in early October.

The cataclysm brought out buyers in droves, not among the pros on the COMEX or London Metals Exchange, but in places like the Perth Mint in Western Australia. "We had a large crowd outside our doors on Monday morning after the market meltdown, and all of them wanted to buy," Mint treasurer Nigel Moffatt told Bloomberg TV.

Similar scenes unfolded across the globe, particularly in China, India, and other burgeoning Asian nations. "People are actually buying everything, gold bars, gold coins," Brian Lan, managing director of GoldSilver Central in Singapore, told Reuters. "People are rushing to get a hand on it."

Does this spontaneous mass mom-and-pop affirmation of gold's value matter compared to the bearish calculations of investment bank and hedge fund experts? Actually it does.

Unlike stocks or bonds, gold leads a vital physical existence. Buyers derive pleasure out of wearing it, presenting it to their beloveds, or stockpiling hunks of it in their strongboxes in the event of social catastrophe. Unlike oil or copper, most gold buyers are individuals or small businesses that intimately depend on individual consumer sentiment.

Some 43% of world consumption last year came from jewelers, according to the World Gold Council. The next largest chunk, 29%, was buyers of coins and bars. Central bank purchases have skyrocketed in recent years to reach 12% of the market. ETFs, though beloved by financial journalists, bought just 6.3% of the world's gold in 2012.

As with other commodities, the physical trade in gold is mirrored by a futures market controlled by professional traders and investment houses. Usually the two are roughly in sync, current demand trends logically shaping traders' bets on future prices. But this is not a usual moment for gold. Physical buyers and futures speculators are showing that they come from different worlds, and are reaching different conclusions about the metal's current price. "Never has the gold market been so deeply divided," says Ross Norman of London-based broker Sharps Pixley.

The professionals (and ETF-investing retail minority) compare gold with other securities options, and have decisively soured on it. Wall Street-style arguments for overweighting gold have been diffuse. But the core one – that central banks' "debasing" of "fiat" currencies would lead to runaway inflation and a concomitant rush into gold as a store of value – has not panned out yet, and does not look likely any time soon. A cascade of bullion-bearish analyst notes this week sounded an almost plaintive note of disillusionment. Clients "point to intense disappointment with gold's failure to rally significantly even during periods when the stars were supposed to be aligned in its favor," wrote Edel Tully of UBS. "Negative feelings toward gold dominate."

The masses lining up to buy gold bars in Perth, Hong Kong, or Mumbai do not believe in stocks or bonds, or often even in banks. They likely shift their "weightings" between US dollars in cash form and gold, and now clearly think the latter is a good trade vs. the former. The number and wealth of these retail gold enthusiasts in the developing world has increased enormously since bullion went into its last prolonged funk in the early 1980s, changing market dynamics for the better. The fact that central banks are buying rather than selling is another major difference between then and now.

In the immediate term, the outlook for gold looks like a stalemate. Pessimists and boosters are not actually so far apart in their concrete price expectations. For all its hurt feelings, UBS expects bullion to settle at $1,400-$1,450 an ounce. The COMEX price at the moment is just below $1,400. Marc Faber, a contrarian hedge fund manager who extolls the current gold crash as a buying opportunity, nonetheless predicts prices may dip further to $1,300 before climbing again.

For financiers, the only more or less solid correlation for gold in recent years has been a negative one with the dollar. If the greenback keeps climbing against the yen and euro, as it has for most of this year, it will make a gold recovery that much more difficult. On the retail demand side, the market to watch is gold-obsessed India. If the economy thrives there and official efforts at taxing down imports fizzle, the market will get an updraft.

The main takeaway of the last week, though, is that gold maintains its millennia-old mystique for broad and increasingly rich swathes of humanity. That will put a brake on the cold calculations of managers in the great money centers.
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No positions in stocks mentioned.

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