By Thomas Pascoe
The Telegraph, London
Tuesday, April 16, 2013

John Kemp at Reuters has calculated that based on a normal distribution, you would expect to see movements like Monday's only once in every 500 million trading days, or two million years. The news which would justify such a price swing is curiously absent -- in fact, my view is that the market ought to be bullish for gold. Something doesn't add up.

In any market, price is determined by the confluence of demand and supply. In many respects supply of gold is relatively fixed. We know the extent of discovered gold reserves and the rate of production. While Cyprus is being forced to dump "excess" gold in order to meet the ever escalating bank bail-out bill, its whole holdings are worth only $750 million, hardly enough to move one of the worlds deepest and most liquid markets to this degree.

In fact, most of the selling pressure has come from ETFs dumping holdings. A record $9.2 billion of net outflows from gold ETFs in the first three months of 2013 are indicative of a loss of faith on the part of investors, as well as of a structural change in a market which has been opened up to electronic trading by the invention of these instruments.

But why would investors wish to sell their gold holdings?

As an alternative store of value, it is easiest to think of demand for gold in terms of demand and supply of fiat money. When demand for fiat money falls or supply rises, people decide to hold less and move their cash into alternative stores (gold, silver and now Bitcoins being the most common). Likewise, when people are optimistic about the state of the economy, they demand more cash because they believe they will be able to invest it in dynamic assets like stocks which will generate better returns.

A surge in demand for money over gold (and hence a fall in the demand for/price of gold) can, therefore, be very broadly justified by either a contraction in the supply of money or a more general optimism about the economy. Are there grounds to believe either of these has happened?

Well, the world's stock of fiat money is not contracting. Quite the opposite, in fact. Japan has just launched stimulus on steroids which will see the developed world's most indebted economy create a proposed $1.4 trillion in Yen in a bid to break free from depression.

Nor is money creation in the West likely to subside. Earlier this month the Fed hinted it would continue buying bonds for the foreseeable future, while there is an expectation in London that Mark Carney's arrival at the Bank of England will see more activist monetary policy here too.

Likewise, the recent decision of the eurozone to confiscate money directly from Cypriot bank accounts clearly creates a template for other crisis-struck nations in Europe and beyond. There is now a major political risk factor in holding large cash deposits. In the meantime, US growth is slowing, Britain's is still anaemic and China's rate of expansion came in below market consensus for Q1. It isn't a booming real economy which is persuading people to cash in their chips.

So what is driving the gold dump if not changes in the macro-economy? I have written in the past that, in my view, the gold markets have been rigged. In this context, the sale of 500 tonnes of paper gold on Friday takes on a different hue. As John Mauldin, one of the most impressive macro analysts out there, wrote in his newsletter this morning:

"Five hundred tons of paper gold contracts were sold dumped into the market on Friday. That is a lot of gold. In short, some people sold gold like they had a gun to their heads, in such a quantity and with such ferocity that the likelihood of their being a for-profit seller is right up there with my chances of winning this week's Masters."

I agree. I have written in the past of the links between the British gold sale at the turn of the millennium and the need to prevent the insolvency of a trading house whose short position had left them unable to meet their commitments at expiry. With this in mind, Andrew Maguire's comments that a similar situation led to a concerted effort to drive down the gold price this time around are interesting, although unverifiable:

http://kingworldnews.com/kingworldnews/KWN_DailyWeb/Entries/2013/4/15_Ma...

The gold market remains one of the most complex and opaque in the world. None of the publicly available data justifies the incredible price movements we have seen recently. It looks as though the market has been rigged again.