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The Story of Gold's 2-Day Collapse

April 4

The Bank of Japan, led by new Gov. Haruhiko Kuroda, announced it would implement $520 billion in government bond purchases per year. The dramatic move meant that the amount of quantitative easing would equate to about 10% of the nation's gross domestic product. Kuroda's decision showed the BOJ's commitment to hit a 2% inflation target in a couple of years and shift Japan from a more than two-decade period of deflation.


But the inflation-supporting measures out of Japan failed to boost gold, which many investors consider as an asset hedge against inflation pressures. Gold's headline -- the same day the BOJ implemented its historic monetary stimulus program -- was that it had posted a 10-month low.

"Japan had really been the trigger," RJO Futures' Streible said. Streible said that when the BOJ announced its massive quantitative easing package, large institutions there had to rebalance and funds sold their gold positions and their yen positions to hold capital in order to hang on to exploding Japanese government bonds.

April 10

A couple of events on April 10 hit the yellow metal.

First, Goldman Sachs (GS) lowered its gold price forecast and recommended investors to short COMEX gold positions.

Second, the Fed released minutes of its March policy-making meeting earlier than expected after the central bank learned someone had inadvertently sent the information a day early to 154 individuals from various entities, including bank lobbying firms, Congressional staffers, and others.

The minutes revealed a growing number of Federal Open Market Committee members who were embracing the idea to scale back the central bank's stimulus programs. Such a move likely would take a bite out of gold prices as the yellow metal's perceived status as a hedge against inflation would fade if the Fed slowed its expansion of the monetary base.

The Fed news coupled with Goldman's short recommendation triggered a 1.8% selloff, normally considered a huge loss. Gold tacked on a slight gain for Thursday, April 11.

April 12

Electronic trading of COMEX gold, by 5 a.m. ET on Friday, April 12, had already seen about a 2% selloff since the prior day's settlement. The movement sparked concern among traders that the market was destabilizing.

A European Commission assessment had emerged that required Cyprus to sell about $523 million in excess gold reserves in order to supplement its bailout program.

But the yellow metal was still hovering above the level of $1,525 an ounce -- a technical number that traders widely perceived as a critical level of support -- which suggested that the worst of Friday's session had finished before most people were arriving at their offices.

"The average broker gets on the phone and starts calling customers: 'Hey, market's down, are you sending in more money, do you want to buy more, or what are your instructions?'" said George Gero, precious metals strategist at RBC Capital Markets. "Most customers make price decisions; they don't like uncertainty, so with the price decisions [they say], 'Oh my God we're down $40, is it true that the Cypriots are going to have to sell gold? Will that spread to the eurozone? Get me out.' And that's what happened."

At 8:30 a.m. ET, some U.S. economic data, including the producer price index and retail sales, printed softer than forecast. The reports added two more weak economic numbers that suggested the economy was not growing as quickly as investors had expected. From about 8:30 a.m. ET until about 10:30 a.m. ET, gold repeatedly tested $1,525.

Then the levies burst.

Large institutional investors work off risk models, and the models started to warn the market was destabilizing.

"They were having massive draw downs on gold and other assets . . . and what they did was they started to reposition drastically," said Streible. "When these larger institutions reposition, we're talking massive size, and they start to seek safety in other markets like U.S. Treasuries, like the U.S. stock market and just getting to cash."

COMEX gold started hitting chart stops and all the computerized momentum traders ducked out of the market. There weren't enough bids in the market to keep the sellers from taking apart the market. In other words, before Friday's drop, people who were looking to get in at a certain price below where gold was actually pricing were slowly pulling out their bids as they started to notice that downward momentum was coming in massive volumes. So instead of buying into the decline, the bidders simply pocketed their bids and moved elsewhere.

Long-only funds liquidated. Essentially, any long position was forced to liquidate positions or else hang on to the asset and swallow the more than 4% drop by settlement on Friday.

When electronic trading opened on Friday night, gold lost even more of its value, which left fund managers to mull over what they'd do when trading reopened in Asia on Sunday evening.

April 15

Traders in the U.S. went to work Sunday night in anticipation of an enormous amount of margin calls. Margin calls butchered opening prices in Asia, and the same went for Europe when it opened for trades. COMEX gold opened almost $100 lower on Monday.

The collapse was on.

The selloff resembled market anarchy. Analysts, brokers and traders in interviews throughout the day said they didn't know how low the market could go.

"The tide was when we picked up margin liquidation and the need to raise additional capital to pay for things, and looking at this, anybody who was a bull had to be saying, 'Well, I can't now justify [buying], I've broken smaller technical levels, I've broken bigger technical levels, and I've completed this huge distribution,'" said Stanley Dash, vice president of applied technical analysis at TradeStation.

Investors slammed gold ETFs on Monday as well.

"ETFs have never lived through a bear market before . . . but they maybe had to be tested a little bit," said Dash.

Mutual funds led deep selling of the largest gold ETF, SPDR Gold Trust (GLD), and on others such as iShares Gold Trust (IAU).

"It had to be from mutual funds," said RBC Capital Markets' Gero. "Mutual funds cannot trade futures contracts; they're forced to go to the GLD or the IAU, because 1940 funds can't trade futures."

The crash in COMEX gold also erased value among gold miners.

"Junior miners were already under significant pressure, and establishing 52-week lows over the past quarter to two quarters," said Jeffrey Wright, managing director of metals and mining at Global Hunter Securities. "Whatever was the 52-week low, congratulations, you guys are setting new record 52-week lows almost every day [since gold's collapse]."

Wright said likely there was not much short sentiment on junior miners and the larger cap gold miners as they've been beaten down so much in recent months.

Amid all the liquidation and the uncertainty as to how far prices could go, there may have been only a small group of large banks and funds that produced arguably the biggest collapse gold as ever experienced. When the dust settled late Monday, COMEX gold closed down $140.30, or 9.3%, as spot gold posted its worst percentage loss since Feb. 28, 1983.

Aftermath

At the CME Group's precious metals dinner on Thursday night, The Gartman Letter editor Dennis Gartman told a gala of women and men in the precious metals sector that he had never seen anything like Friday and Monday in his 40 years of covering the commodity. He admitted there had previously been larger percentage drops in gold, but the space had never seen $100 drops.

As for who drove down this market by 13% in some 36 hours, you should know that it wasn't retail investors.

"I'm assuming it was large funds, this was not a march of individuals," said Gero.

-- Written by Joe Deaux in New York.

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