Gold’s recent collapse has triggered some questions as to the cause of the weakness more fundamental that the extraordinary dumping of gold last Sunday night just as Shanghai was opening. That selling triggered a rout that has taken gold under $1,100, to six year lows. Six major reasons can be provided, with different time-frames and differing importance.

1.  An improving U.S. economy raising the prospect of an interest rate hike this year. Though the Federal Reserve may well raise the Fed Funds rate this year, I doubt this would signal the start of a rapid series of rate increases (as is often the case when the Fed turns); Janet Yellen emphasized as much herself, talking of a "gradual" return to "normalcy". Moreover, a quarter point hike in the rate is surely just about the most telegraphed rate hike in history, so should be fully discount in the gold price.

2.   Related to this is a reasonably strong stock market, making the need (or perceived need) for gold as insurance less than in the past. Typically, investors look to hedge their stock market exposure with gold when they are concerned about the stock market. We look at the present situation differently. The stock market it getting more and more into overvalued territory with the risk of a correction increasing.

The dollar is strong amid an improving economy and rising stock market

3.  The dollar has recovered from its earlier correction and has resumed its upward march. The dollar has benefited from the safe haven concern, first over Greece and then over the Chinese stock market. This, I feel, is perhaps the most important factor affecting gold right now, particularly against the background of a reasonably healthy economy and stock market. Gold likely won’t recover meaningfully until the dollar peaks.

4.  Lessening global concerns, following the Greek deal and Iran nuclear agreement. Whether these crises have faded permanently is a different question of course.

There are concerns surrounding China

5.  Chinese gold purchases, announced Friday, were less than expected. As usual, I feel the optimism was overdone.  An increase from 1054 tonnes in 2009 to 1658 in Bank of China’s gold reserves is quite a hike; that’s over 600 tonnes in six years, and a faster rate of increase than previous increases in gold holdings. It increases China’s gold as a percentage of its foreign reserves from 1.1% to 1.6%, again a significant jump, in my view.  Of course, 1.6% remains a low allocation on a global basis, though we should not forget that China’s foreign reserves have jumped a lot over that time frame as well. 

6.  Concern about a slowing Chinese economy and its impact on purchases of all commodities including gold. No question this has had some effect on many commodities in the past several quarters, though gold buying remains robust.

In all, the market has turned extremely bearish; all indicators are very negative, including commodity commitments are at the least bullish in many years, while another half-a-billion was pulled from gold ETFs last week. In such a climate, all news is viewed through a bearish prism. The most important factor, and, absent a black swan or sharp deterioration in another of the factors above, the one thing that needs to change to turn gold around remains the dollar.

This may represent the rout that the market needed before starting to claw back up, exaggerated by being a seasonally weak period.  And the gold stocks are at such extreme lows that the rally—whether it starts next week or next month—could be strong. So we would be buying, selectively and cautiously by all means, but buying, buying when others are selling.