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Gold's beauty contest may still have legs

WHAT'S ailing gold? After a rally from its lows in mid-December to a peak of US$1,358 an ounce Jan 24, the metal has lost all its vigour. Prices traded sideways before slumping in recent weeks to the low 1300s. Without some gains soon, the 50-day moving average looks likely to soon slip below the 100-day measure, considered a bearish signal by many traders.

This isn't purely about the strength of the greenback, which is often blamed for declines in the price of dollar-denominated commodities. Converting the US dollar gold price into special drawing rights - the reserve asset created by the International Monetary Fund with a value based on a basket of global currencies - illustrates the point.

A fair proportion of the past year's weakness does indeed seem to coincide with a rising dollar, but in the most recent month declines have, if anything, been worse in SDR terms. Rising interest rates (which tend to decrease the attractions of coupon- and dividend-free commodities) haven't helped.

While gold managed to rally in tandem with US Treasury yields in December and January, the most recent surge above 3 per cent matches the timing of the metal's more recent sickly spell.

Still, gold is up by more than a fifth since the US Federal Reserve started its current tightening cycle. Think about the long-run performance of gold and interest rates for a moment and it's clear there's anything but a mathematical relationship.

A simpler explanation may be better: investors are participating in a Keynesian beauty contest, with decisions driven more by expectations about the behaviour of other market participants than any irreducible core beliefs. When gold is rising, they find excuses in the form of currencies, interest rates and inflation to jump on the bandwagon.

Exchange-traded funds

When they're falling, those explanations look more threadbare. That's why it's worth taking a look at the behaviour of exchange-traded funds (ETFs), the most volatile subset of gold consumers. Unlike every other group, they can frequently switch from buying to selling.

One such bout of bearishness both resulted from, and contributed to, the metal's four-year slide from 2011 to 2015. In recent quarters, buying appears to have all but dried up. Just 74 tonnes were added to the ETF total in the nine months through March, according to the World Gold Council; a Bloomberg-compiled index produces a similarly weak number of around 99 tonnes.

All that said, there's a possibility of change in the air. The June-August period tends historically to be mildly bullish for this highly cyclical metal, second only to its traditional surge in the first two months. ETF purchases have been picking up since the start of this quarter: the 1.9 million troy ounce increase during April was the strongest in 14 months. In addition, a whiff of chaotic geopolitics is afoot, another favourite explanation for gold's mysterious movements.

Most of all, watch out for the lure of contrarianism. Investment funds' long positions in US gold futures have slumped to a nine-month low of 51,985 contracts as of May 1. That superficially looks like a bet on falling prices, but more often than not such moves are a sign that investors have got themselves too short.

Since gold markets bottomed at the end of 2015, on each of the five occasions when net long positions fell below 100,000 contracts, a rally soon emerged. On average, prices were up 4.8 per cent 50 trading days later.

While gold's charms may have dimmed, they haven't been extinguished. It's too soon to assume this particular beauty contest is over. BLOOMBERG

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