That was not super, Mario!

According to media reports, a statement by ECB president Mario Draghi that Cyprus would sell a major part of its gold reserves to raise about 400 mil euros (as a part of the bailout package agreed between the troika and Cyprus’ president) was the trigger for the massive sell-off in precious metals. This was not super for several reasons.

Silence is golden. This is not only the title of a song performed by a group called the Marmalades when Mr. Draghi was a teenager, but also an old adage. The volume of total gold sales intended by Cyprus is only the turnover in the gold market of a few days. Nevertheless, in every market, the announcement of a larger sale leads immediately to weaker prices. Thus, Mr. Draghi’s statement reduced the potential revenues Cyprus might obtain by more than 230$/oz within two trading days. Therefore, the few words of the ECB presidents reduced the expected proceeds for Cyprus by almost 15%. This was really not a super help for Cyprus. Mario Draghi better had kept his mouth shut.

The gold market is a place, where some market participants believe in conspiracy theories. To make it clear, we are not convinced by those theories. Nevertheless, the plunge of the gold price triggered by the statement of Mr. Draghi revived the conspiracy theory that this comment was part of an orchestrated action by central banks to manipulate the market. Central banks were also supposed to be the force behind selling 400 tons of gold on Friday April 12 at Comex. On analyst even accused central banks to be the dark force responsible for declining prices of gold on some days either at the opening of the pit session at Comex or the afternoon fixing in London. The argument by the gold bugs is that a rising gold price would express distrust in paper money and therefore, central banks would manipulate the price down to signal that fiat money could be trusted and that gold would not be a safe haven. However, if major central banks would really sell gold to push prices lower, it would be reflected in their balance sheets. And there is not any hint for market manipulation.

Gold held by the central banks are part of their reserves. Any disposition about the management of these reserves is in the discretion of the governing body of the central bank. In the eurozone, the ECB and the national central banks are independent and should not set under any political pressure, neither by the EU nor national governments. This is guaranteed by the EU treaties. However, in the case of Cyprus, the insistence of the EU on selling gold reserves to obtain the requested contribution of Cyprus to the bailout is a clear violation of the independence of central banks in the eurozone. What is worrisome is that the ECB did not protest against this demand but Mr. Draghi even gave his approval.

That the plan of Cyprus to obtain 400 mil euros from the sale of a part of its gold reserves led to such a steep plunge of gold and other precious metal prices is also the result of the mismanagement of the debt crisis by European politicians. Too often, politicians, in particular the German finance minister, promised first that a certain measure would not be taken, later then it was only in a special case before it became normal procedure. Thus, all trust had been destroyed. Therefore, it really does not come as a surprise that the market immediately speculated that also Ireland and the southern European countries might be forced by the EU to sell gold reserves. And the gold holdings of Spain and Italy are far higher than those of Cyprus.

If a market plunges, the usual suspects are the infamous hedge funds shorting to market to make a quick profit. This was also a suspicion some commentators voiced after the plunge continued on Monday this week. At a first glance, the record volume of gold futures traded at Comex on Monday at more than 750K contracts in the front month June contract appeared to confirm this suspect. However, the latest CFTC report on the “Commitment of Traders” surprised. Large speculators even increased their net long position in Comex gold futures in the week ending April 16 to 128,882 contracts, a plus of 9,523 contracts. Furthermore, if hedge funds really would massively short gold futures, then one would expect a rise of open interest. However, the total open interest declined by almost 2,500 to 413,083 contracts.

The increase of the net long position held by large speculators, the physical buying from retail investors and commercial demand in Asia after the plunge, these all are positive indications. Furthermore, the market was oversold and technical indicators returned from the oversold back into the neutral zone, which is normally a buy signal. Thus, there are good chances for a recovery of gold and other precious metals. However, the sentiment, especially among analysts at major investment banks, is still negative and outflows from gold ETFs continued. Therefore, the risks to the downside remain considerable.