Cyprus issue causes us to reassess near term Gold Prospects

As regular readers will be aware, we have been bearish gold since last summer and laid out our case for continued weakness through this year in the guide below. As you will see in the blog below, the issue in Cyprus is, in our opinion, a game changer.

Basically ever since Mario Draghi comments in defence of the Euro last July, gold has been declining – we can surmise that some of the “flight safety” premium has therefore dissipated out of Gold and should tensions surrounding Europe rise again that there is good scope for this to be reintroduced to the price. We think tensions will increase as we go through the spring/summer and the implications of the Cyprus issue become more wide felt and with the short term oversold technical’s we are no longer as bearish on gold, particularly considering the heavy unwinding of the bull position in the yellow metal.

Soros, and Louis Bacon – 2 goliath’s of the hedge fund world have also been sellersof the metal in recent months per their SEC 13-F filings, with only poor old Paulson holding the faith in this downdraft. Or we presume so, as we will not see his SEC filings for the first quarter of this year for some months yet – he may also have thrown in the towel looking at recent price action – if so that would probably be the big contrarian signal to get long!

If we look at SPDR Gold Trust -the largest gold fund and one of the best trackers for gold prices, we see it surpassed $173 in October last year but then entered a bearish period dropping to the current $156.08 level seen recently. The fund declined almost 10% since October and is down 3.7% YTD.

Amazingly, and what is to be the focus of the next edition of our magazine out in the next few days, the Gold Miners ETF’s have lost more than 30% since the end of 3Q12 while the S&P 500 has risen 7.5%. This level of extreme underperformance is very rare.

The big picture for gold has deteriorated due to several factors including the better than expected economic data coming from the US, the improvement in the Eurozone, the rise in equities and the stronger dollar. The calm and quiet coming from the Eurozone following July’s Draghi comments last also helped the bearish case for gold. For the first time in several years, investors weren’t buying on dips anymore. Not surprising given the kind of performance we have been been experiencing in equities with the S&P 500 at historical highs and almost 9% higher this year.

Unfortunately (or fortunately, depending on your perspective), that picture has changed. What could derail the bearish gold trend is the Eurozone and once again we have problems brewing For the first time ever, someone wants to mess with deposits and which are the engine of our capitalist system. Until now the ECB, the European Commission and the IMF recognized the need to assure the flow of money to banks to avoid a financial rupture but also not to sacrifice innocent saviours at that altar. Assuring the safety of deposits up to €100,000 was a measure taken with that in mind. Inexplicably, they now want to create a precedent in Cyprus and confiscate money from bank deposits. Even if they step back from this and which they appear to be doing in part, the damage is already done and they may face a run on Southern European regional banks. At the same time, this single measure may lead to Russian retaliation given the large deposits by some of its wealthier citizens in Cyprus through reducing its supply of gas to Europe. Cyprus may have to give up its inclusion with the Eurozone and actually ask Russia for help.

Letting a country that accounts for just 0.2% of the union’s GDP cause this kind of trouble was the stupidest thing ever to ever come out of the troika. It’s so stupid that it begs the question if it was done on purpose… German bonds are likely to rise (yields drop) and Gold is in favour right now as risk aversion will return until there are more clues about the wider implications of the Cyprus story.