Testing time for gold and other commodity markets

With falls in all major markets this week, share investors received another reminder of how volatile their investments can be. The triggers this time were speculation that the gold price was on the way down, and the downward pressure on other commodity prices because Chinese growth is lower than predicted.

For the Australian market especially, commodity prices are important because of the large weighting of mining and energy companies in the share indices. But this week’s falls led down by the price of gold were widespread around the world even in countries not as dependent on Chinese growth as is Australia.

At this stage, there is no evidence to suggest that the Chinese economy is in serious trouble and likely to drag down world growth. The latest quarterly growth figure of 7.7 per cent released last week, though less than the expected 8 per cent per annum, is still above the projected 7.5 per cent growth rate in the five-year plan.

The plunge in the price of gold followed investment bank Goldman Sachs warning of an imminent bear market due to improved investor confidence. There is no certainty that the Goldman Sachs analysis and the rapid fall in the gold price this week will prove to be accurate indicators. The reality is that commodities markets, especially for precious metals, are subject to large speculative transactions. It will take some time to determine whether the plunge in the gold price represents a genuine reassessment or was the consequence of aggressive short selling by hedge funds. For these traders and speculators, widespread publicity about the possibility of lower prices presented a rare opportunity to make large profits by short selling gold.

Among other things, their selling helped induce speculative holders to sell all or part of their gold holdings to reduce their losses or realise any remaining gains. In this process, prediction of a falling price has proved to be a self-fulfilling prophecy. The losses incurred this week will inevitably reduce the speculative demand for gold and reduce its long-term value. But there are limits to how far the price will fall because the short sellers eventually have to close out their positions by buying.

These will be testing times for both the gold and other commodity markets because of the large losses incurred over the past week. Investors should not expect a quick recovery in commodity or share prices while many traders lick their wounds from the latest success of the short sellers.

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Daryl Dixon

Executive Chairman

Daryl Dixon is one of Australia’s foremost investment experts and a well known writer and consultant. He has provided trusted advice to thousands of personal clients over more than 25 years and is an acknowledged expert in the areas of tax, superannuation (including public sector superannuation), social security and investments.

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