Hard-hit gold bulls not yet out for the count

By Jan Harvey

LONDON (Reuters) - Gold's toppling from record highs, culminating in Monday's unprecedented $120 price plunge, has investors asking whether a decade-long bull run is over. History would suggest that while gold has taken a beating, it is far from down and out.

Monday's tumble to around $1,535 an ounce dragged prices 20 percent below the record $1,920 reached this month. But since its rise from just over $250 in early 2001, gold has bounced back from bigger drops, having fallen 25 percent between May and June 2006, and 27 percent in October 2008.

The 2008 episode saw gold treated like any other high risk asset when the collapse of Lehman Brothers sparked heavy selling across financial markets in a widely-documented "dash for cash" -- after which it bounced back hard to record highs.

"Gold and other real assets are not immune from global sell-offs, and this is a textbook example we are seeing now," said Bayram Dincer, an analyst at LGT Capital Management.

"If you want to draw an analogy, look at 2008, when the Lehman fall saw gold collapsing around $250. The markets are in this 2008, global post-Lehman sell-off mode."

In the short term, the sharply higher volatility in gold typified by Monday's trade will have battered its already tarnished reputation as a haven. Prices could have further to correct, given their hefty run-up of recent months.

But expectations that, longer term, other asset classes could prove still more of a risk, coupled with the low interest rate environment, are likely to push prices higher when selling peters out.

While gold may be seen as less of a haven than in the days before $50 daily price moves became a regular feature of the market, it is hardly alone in seeing heightened volatility.

"Clearly any move like this is going to make people at least question the assumptions they had that any euro zone stress might be positive for gold," said David Jollie, an analyst at Mitsui Precious Metals. "General financial market volatility is a threat to any asset."


The euro, stock markets and raw materials such as oil and copper have all posted losses this month as investors sold these nominally riskier assets in response to growing concerns over the euro zone debt crisis.

Gold seemed to have reached a tipping point as worsening financial market conditions forced some investors to realize fat profits in the metal to cover losses elsewhere, and on a rush to the greater liquidity of the dollar and Treasuries.

"For now, investors are only finding comfort in the relative safety of cash," said UBS analyst Edel Tully.

These kinds of fears usually benefit gold, so its switch in role from haven to source of funds shows not only how much stress the financial markets are under, but also how overstretched the metal had become.

Signs that gold was ripe for a correction were rife after its sharp rally to record highs in early September -- which saw it surge by 28 percent in just over two months -- was followed by a period of intense volatility.

"The rise in volatility taking place in the gold price was clearly an indication that gold was no longer a low-risk asset," said Natixis analyst Nic Brown.

"We are unwinding much of recent move over last two to three months. It's too early to say whether it's the big burst. It could be, but it's equally possible that it could be what allows the market to push over further highs over the next few months."


Holdings of gold-backed exchange-traded funds have remained relatively steady during recent sell-offs, suggesting they have been reasonably resilient to short-term moves.

Analysts say recent sharp price moves are a likely result of repositioning by large institutional investors like hedge funds. But these are not the only, or even the main, buyers of gold.

Small-scale retail investors, particularly Asian buyers looking for a store of wealth and a hedge against inflation, have also been key bullion buyers, and are likely to remain so.

In the short term, investors are likely to be wary of "catching a falling knife," and buying into the market before the correction has fully run its course. But they may be swift to do so as prices stabilize, analysts predicted.

While gold's retracement was sharp, spot prices are still up 7 percent this quarter, and nearly 14 percent on the year, despite the failure of a number of key risk factors, like fears of a U.S. default or fresh monetary easing, to materialize.

"In Q4 2008... the gold price fell by 25 percent over a fairly short period," said VM Group analyst Carl Firman. "But it does tend to recover at significantly higher levels."

"I think what you will see could be a gold recovery very similar to the one you saw in Q1 2009, when the gold price recovered long before other assets hit bottom."

"We are still looking at a high inflationary environment, we are looking at negative real interest rates, there are all sorts of uncertainties out there," he said. "That has got to benefit gold, at some point."

(Additional reporting by Amanda Cooper; Editing by Anthony Barker)