An important principle that is present in all markets is "overshooting." Because (free) markets are unavoidably created by imperfect humans and are influenced by human actors with all sorts of motivations, there are always going to be "corrections."
For this reason, market participants will always overshoot one direction or another on prices. That's how prices work; you can't really tell if they've risen too high or fallen too low until that's actually the case. That's when the natural correction mechanism of price discovery kicks in: the sellers will outnumber the buyers (or vice versa) until these two forces come into balance.
According to mining and investing expert Robert Appel of Profit Confidential, just such a "critical juncture" is around the corner for gold.
Gold Shorts Galore
For the past several years, Appel points out that taking out a short position on gold became "the safest short of the decade." (Shorts are inherently dangerous because the potential amount lost is theoretically infinite, bounded only by how much the asset price rises.)
He continues: "The more you used the trade, the better it worked. No one really cared why or how. Taking gold to the woodshed for a sound beating had mysteriously became the most reliable trade of the period. (One pundit even referred to shorting gold as 'a trade protected by low friends in high places.')"
As his colorful language illustrates, traders were shorting gold willy-nilly because nobody was willing to take the other side of the trade. The gold bulls had "capitulated," or given up the market, and were no longer interested in buying. Sentiment surrounding precious metals among market participants sank to all-time lows. This also drove the entire gold mining sector into the ground (with the aid of the prolonged commodities rout in general).
As that principal of Newtonian mechanics goes, for every action there is an equal and opposite reaction. This is just as true of markets.
East of Eden
While Appel rightly has no confidence in the validity of the COMEX paper gold markets in the West, he believes that a development on the other side of the world will (eventually) cause the swing in sentiment and gold prices that bulls have been waiting for.
We all know that physical bars of gold have been rapidly migrating from West to East—from (increasingly empty) COMEX vaults to places like China, India, and Russia. In fact, one wonders how the world's two most populous nations and another global power could be buying so much gold and yet prices just keep slipping.
Enter the incipient Shanghai Gold Exchange (SGE). Appel believes this physical gold exchange, with its emphasis on 1:1 ownership-to-inventory ratios and no over-leveraging, will one day wrest bullion prices from their current bearish slump. This principle (so despised by Western bankers, apparently) is what would help keep speculators honest and prevent the kind of over-leveraging we see on the COMEX.
He invites us to consider the paradox of China. Through their ownership of several high-grade South African gold mines (along with onshore mining), China is the world's top producer of gold. Moreover, it doesn't export any of that gold. Yet, at the same time, China also imports more gold than anyone. This only makes sense if they are planning something very big with all of that precious metal.
Enter the SGE
With a functional gold exchange in the country, it's unsurprising that the Chinese are also planning to orchestrate their own gold fix. They've even given hints at these plans (very uncharacteristically, Appel points out) several times. It's clear that China not only wants to be the center of the gold market, but that it is doing so very strategically because the country's leaders see it as an important tactical advantage. It's true enough: you often hear how gold is the greatest fear of manipulative bankers because it forces them to be honest and act within their limits.
There may be something to Appel's observation that the Chinese are culturally attuned to solving problems gradually over time rather than in impulsive schemes like we do in the West. (Think: quantitative easing, massive bailouts, etc.) With this in mind, the key "turning point" where China assumes control of the global gold trade (and, more importantly, the price discovery mechanisms) may be a long-term process that doesn't erupt in 2016 or even 2017. Nonetheless, if the Chinese can indeed successfully execute their gold strategy, it could trigger a multi-year bull run for gold prices that resembles the rally from 2009 through 2012.
The opinions and forecasts herein are provided solely for informational purposes, and should not be used or construed as an offer, solicitation, or recommendation to buy or sell any product.