Gold Selloff Continues as Hedge Funds Deleverage

By: Mark_OByrne

Gold's sell off continued yesterday and gold has fallen to new 11 month lows. Gold recovered slightly in Asian trading before a further sell off in early European trading. Gold remains under serious pressure as the dollar's rally has continued with the dollar reaching a 1 year high against the euro of $1.3890. Meanwhile, oil has fallen again and NYMEX sweet crude is now near the psychological $100 level.

It is important to remember that gold's fall in recent months is primarily a fall in terms of the recently strengthening US dollar. Gold has remained quite firm in euros and sterling as seen in the charts below. Indeed since the start of the credit crisis gold remains up some 10% in euro terms and by nearly 26% in sterling terms.



The sharp selloff in gold continues and there is increasing informed speculation that leveraged hedge funds are dumping positions in equity and commodity markets after incurring significant losses in recent weeks.

Fears of a meltdown in the credit default swap (CDS) market and in the financial system remain elevated. As the markets digest the implications of the government's nationalisation of Fannie and Freddie and possible bankruptcy of Lehman Brothers, the market for trillions of dollars of credit default swaps is facing a possible meltdown. As we have warned for many months, the losses in credit derivative contracts will result in billions and possibly trillions of dollars of losses for insurance companies and banks.

At the same time hedge funds are facing funding issues from investment banks. Morgan Stanley and Goldman Sachs will only extend new credit to hedge funds and let them place new leveraged bets if Goldman's own corporate bonds are rising in value. According to the FT, if Goldman's bonds rise, allowing it to issue new debt at favorable rates, then it extends fresh credit to its hedge-fund clients. But should Goldman's bonds fall, capping its own flow of finance from the capital markets, then the highly-geared hedge funds must meet margin calls or fold. The message is that "if our firm is in trouble, we would rather fund ourselves than fund you (hedge funds)," the paper quoted a Morgan Stanley brokerage executive with knowledge of the arrangements as saying.

The short term trend in gold remains down but as the carnage in the financial system deepens, gold's safe haven qualities will again come to the fore. While gold has fallen in recent weeks it is important to remember that it has fallen by far less than equity markets and property markets and has vastly outperformed those markets over the medium to long term.



Today's Data and Influence
Ahead today, US Trade Balance figures and Initial Jobless Claims are both due for release at 13:30 GMT.

Gold and Silver
Gold is trading at $742.00/742.70 per ounce (1115 GMT).
Silver is trading at $10.68/10.74 per ounce (1115 GMT).

PGMs
Platinum is trading at $1144/1154 per ounce (1115 GMT).
Palladium is trading at $218/222 per ounce (1115 GMT).

By Mark O'Byrne, Executive Director

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