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Forex pairs in this Article » GOLD, USDOLLAR, EUR/USD
Gold has absolutely collapsed through Thursday’s trading session. The numbers are staggering. Through the end of the New York session, the precious metal was down well over 5 percent or $70 on the trading session. This incredible move hammered the market easily below the $1,300 level and ushered spot to levels last seen in September 2010.

If today’s price action were taken alone, it would seem that this is merely a one-off that may have been spurred by a wave of stop positioning or the momentum following an exceptional order. However, we have to take this decline in context of the bigger picture to appreciate how the overall trend is developing.

This incredible tumble is coming little more than two months after a record-breaking 14 percent-plus collapse in mid-April. With these two big acceleration periods (see the chart below) are fit into a larger and consistent bear trend. This trend has seen the metal nearly $400 or 24 percent lower since the beginning of the year; over $500 or 28 percent since last September’s highs; and nearly $650 or 33 percent from the record high set back on September 6, 2011.

Gold_Suffers_its_Fifth_Largst_Drop_on_Record_as_USD_Soars_Post_Fed_body_Picture_5.png, Gold Suffers its Fifth Largest Drop on Record as USD Soars Post Fed!Charting Created by John Kicklighter usingMarketscope 2.0

By the Numbers

Before looking at the bigger bear trend implications, we should establish how remarkable the recent collapse has been. As we can see below, Thursday’s decline is the fifth largest dollar-based move on record. This is a skewed view somewhat as higher prices mean bigger notional corrections are possible.

Gold_Suffers_its_Fifth_Largst_Drop_on_Record_as_USD_Soars_Post_Fed_body_Picture_6.png, Gold Suffers its Fifth Largest Drop on Record as USD Soars Post Fed!So, for a more economical comparison of this remarkable move, we look at percentage change. The more than 5 percent plunge is still exceptional. It is the second largest move since the financial crisis / Great Recession of 2008-2009. Why was gold dropping more rapidly during that period – when there is theoretically a greater demand for a safe haven? That leads us to the fundamental aspects of the current tumble.

Gold_Suffers_its_Fifth_Largst_Drop_on_Record_as_USD_Soars_Post_Fed_body_Picture_7.png, Gold Suffers its Fifth Largest Drop on Record as USD Soars Post Fed!The Fundamentals

Gold plays three general roles for the global market: traditional safe haven asset, a simple hedge to inflation and an alternative store of wealth to typical currencies and fiat assets. All three of these roles have diminished over the past year.

As a simple hedge to inflation, there simply isn’t rapid price growth to warrant a need to offset the rising prices of goods. This is an incredible situation to investors that have seen stimulus surge and economic activity slowly recover for many of the world’s largest economies; but it is reality. As for the ‘safe haven’ aspect, there are a few critical qualities that must be met to keep investors’ confidence: liquid and low volatility. While the metal is more liquid than many markets, it doesn’t rival other ‘safe havens’. More importantly, volatility in gold has exploded – delivering rapid losses for those holding for safety.

That leaves us with its role as an alternative to ‘manipulated’ currencies. This is still a meaningful dynamic as central bank efforts to bolster growth and end deflation have led to unprecedented increases in balance sheets (which has the - desired or undesired - side effect of devaluing currencies). Yet, here too, we have seen the market ignore the distorting effects of stimulus and remain within the FX world. The catalyst for this most recent move can be seen below. The US dollar has surged in the wake of the Fed policy meeting in which the group made clear its intention to eventually slow the pace of its support via QE3.

Gold_Suffers_its_Fifth_Largst_Drop_on_Record_as_USD_Soars_Post_Fed_body_Picture_8.png, Gold Suffers its Fifth Largest Drop on Record as USD Soars Post Fed!The Market Positioning Response

An argument has arisen in the market that the decline in gold prices is ‘unnatural’ because it is established in the unwind of ‘paper’ gold – in other words, investors are selling assets that are derivatives of physical gold (ETFs, Futures, etc). It is true that there is a severe exit from these paper assets. In the chart below, we can see the incredible outflow of interest in total ETF (exchange traded funds) which in turn leads to reduced holdings of the precious metal for exposure.

However, the source of the move imposes its influence regardless of what asset its starts from. All graphs here are showing spot – physical – gold price. The selloff of physical gold by the funds is just as real as an individual or central bank unloading the metal.

Gold_Suffers_its_Fifth_Largst_Drop_on_Record_as_USD_Soars_Post_Fed_body_Picture_9.png, Gold Suffers its Fifth Largest Drop on Record as USD Soars Post Fed!Looking more closely at the speculative aspect of the market, we can see how those trading the market simply for capital gains are positioning. The Commitment of Traders (COT) report from the CFTC shows that net speculative positioning in gold futures contracts is the lowest we have seen since the beginning of 2007. That looks tempting as an ‘oversold’ positioning on a contrarian track, but markets can remain oversold for a long-time when the time frame is this large and it can grow even more oversold. (See how retail traders are positioning in gold with the DailyFX-Plus SSI)

Gold_Suffers_its_Fifth_Largst_Drop_on_Record_as_USD_Soars_Post_Fed_body_Picture_10.png, Gold Suffers its Fifth Largest Drop on Record as USD Soars Post Fed!What we have seen in gold this past session, is not a one off event. We witnessed another instance of incredibly intense selling just two months ago. Furthermore, we have seen consistent selling pressure for months following a few years of general congestion that followed the test of record highs.

There is certainly a possibility of short-term rebounds in the price of gold; but this pace of selling should encourage every potential trader to step back and think about the conditions that would support a bullish move and weigh the possibilities of how significant the rebound can go. As a safe haven, inflation hedge and alternative store of wealth; gold has seen its fundamental position change systemically over the months.

--- Written by: John Kicklighter, Chief Strategist for DailyFX.com

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