The number of analysts and investors prepared to believe that the bull market in gold had ended was growing late last week, but nobody expected the precious metal to fall 15 per cent in two trading days, and by 9.1 per cent on Monday in New York, the biggest one-day loss in percentage terms since February 1983.
Gold is, however, a three-tier market - real, strategic and speculative: the sudden plunge occurred in the speculative layer, and is capable of at least partly reversing.
The first tier of the gold market is the physical market for gold, which has been fairly stable. The World Gold Council estimated that gold supplies in 2012 fell 1.4 per cent to 4453 tonnes. Demand was down by 4 per cent in tonnage, to 4405 tonnes.
The mix changed. Central bank purchases were at 48-year high and demand from institutional investors was strong, but consumer demand weakened as buyers baulked at high gold prices. Overall demand in 2012 was 15 per cent higher than the average for the previous five years.
The strategic tier is currency-focused. Gold is priced in US dollars, and its price moves mechanically up when the US dollar falls, and down when the US dollar rises. The fact that gold supplies are relatively constant adds another dimension, however, because gold is a "currency" that is not debased by a sudden expansion of supply.
The strategic tier was the dominant one after the global crisis. Gold rose from about $US600 an ounce before the global crisis to a peak of $US1900 an ounce in September 2011, largely because the US dollar's value fell as the US Federal Reserve aggressively created cash to add quantitative easing stimulus to interest rate stimulus that was already fully deployed.
The third tier of the gold market is speculative trading, and New York's Comex futures market is its locus. On one estimate by a gold fund manager, trade in gold futures on Friday and Monday equalled 112 per cent of annual gold production. It was almost exclusively on the selling side, with hedge funds believed to be at the vanguard. It may in other words have been a similar pack attack to the ones mounted before and after the global crisis on vulnerable companies and, in Europe, vulnerable countries.
That gives you a clue to what gold could do in the near term. Traders who opened up short (sold) positions in the futures market on Friday and Monday pushed the metal down through two critical support levels, and locked in profits as the gold price gapped lower. The metal could recover some of the ground as that speculative selling activity eases and buying support re-emerges at lower levels. On Tuesday the first, tentative attempt to find a new base was under way as gold climbed from a 10.48am low of $US1321.95 (down from about $US1560 an ounce before the slump) to $US1373 at 4pm.
However, that is not to say that gold can bounce back from this selling attack and go on to eventually post new highs.
Pack attacks aim to magnify weaknesses that already exist, and before the price plunge calls that gold's bull run was over were proliferating. Some cited selling by hedge fund investors including George Soros, others said short positions on Comex were building, but investment banks including Goldman Sachs, Societe Generale and Citigroup also based predictions that the gold price would trend (not plunge) lower on a view that gold's strategic value was reducing as global growth returned, albeit spasmodically.
The US Federal Reserve is still pumping into the system $US85 billion a month of new quantitative-easing cash, and Japan has now begun a $US75 billion quantitative easing program of its own. But gold had become less sensitive to bad economic news and market shocks this year, and the last two monthly minutes of Fed rate-setting meetings have both revealed that the Fed is actively discussing when QE should be backed out. The odds on QE extending much beyond the end of this year are lengthening even though recent economic data from the US and also from Europe and China has been disappointing.
Committed gold investors on the other hand see the metal as a store of real value in a degenerate financial system. They believe its latest plunge is a result of market manipulation, that attempts to fix the world's finances will fail, and that gold will find new highs as the collapse of the post-crisis resurrection project becomes apparent: more than the metal's longer-term direction depends on who is right.