After hitting $700 per ounce in May, gold has retreated since then by nearly 9%. A similar situation occurred in February and March, following the world wide stock market mini crash. Gold also was being dragged down.
At that time, a 10% decline in a single day of the Chinese stock markets led to panic around the globe. People feared that the stock market decline of China could lead to a contraction of the world economy, with the Far Eastern country being an important global economic player. Afterwards, this mini crash appeared to be merely a correction, providing a buying opportunity.
From safe to risky
Although gold is mostly seen as a safe haven in times of turmoil and uncertainty, the market is perceiving gold more and more as a risky commodity. The turbulence of the sub-prime mortgage market and the near collapse of two hedge funds of Bear Stearns showed this again very clearly.
As the stock markets retreated, so too did gold. In recent weeks, it became clear that these Bear Stearns hedge funds were in serious trouble after taking wrong bets on so-called collateralised-debt obligations. The prices of these 'assets' were badly hurt in March and April as defaults on sub prime mortgages to people with poor or limited credit histories, increased. Bear Stearns, the second biggest US underwriter of mortgage bonds, will probably take on at least $3.2bn to rescue a hedge fund. The question is whether these problems will lead to a credit crunch.
The increased uncertainty not only hurt stocks but also gold. This week the (August delivery) gold future sold off to almost $640. Around that level, physical buyers and bargain hunters stepped into the market to take advantage of lower prices. Gold strengthened again on the back of a weaker dollar, firmer oil prices and a recovery of stock markets.
Fed boosts gold
Stronger stocks mean improved optimism about the economy and thus demand for metals. Moreover, the Fed held the Federal Funds Rate as expected, unchanged, at 5.25%. The Fed signalled that the core inflation is moderate and it expected the US economy to grow moderately in the forthcoming quarters. These statements took away some uncertainty which also helped gold.
If these developments can help put gold back in harness for a roller coaster ride up to the $700 level again, only time will tell. Gold, now trading at $650, has first to take out resistance at around $660 and break out of the short term down trend. If successful, gold could rally significantly. The next resistance level could be found at $680. The key support level is $640 for the short term and, if broken, the next support could be found around $620. Considering the risk/reward ratio, odds are on the upside. Of course, for long gold, any significant break below the $640 support level and the bullish scenario will diminish.