Saxo Bank: Gold no longer overbought but still under-owned

After the big selloff in gold and silver, a Saxo Bank analyst says the metals are no longer overbought, but they are still under-owned.

After peaking near $4,400 an ounce, gold got hammered lower on Tuesday and Wednesday, falling to close to $4,000 before stabilizing at around $4,100. Silver dropped even more substantially in percentage terms, plunging from over $54 to the $48 range.

Saxo Bank Head of Commodity Strategy Ole Hansen said that after the much-needed correction, gold and silver are no longer overbought.

From a technical standpoint, an asset is overbought when the price runs up extremely fast relative to the recent trend. Technical analysts use various metrics to determine whether an asset is overbought. Those metrics have now unwound.

However, looking at the bigger picture, Hansen said the metals are still under-owned in portfolios and the structural drivers behind the precious metals rally remain intact.

That means the bulls likely have more legs.

Hansen said the “forceful correction” wasn’t unexpected, calling it “a natural reset after a powerful nine-week rally that saw gold gain 31 percent and silver 45 percent.”

“The risk of correction in gold and silver has been steadily rising in recent days, though exceptionally strong pre-Diwali demand helped support prices. However, a very technical extended rally combined with renewed ‘risk-on’ tone across stock markets, a firmer dollar, and not least the start of Diwali — which typically signals softer physical demand from Asia — have made traders increasingly cautious, more focused on protecting gains than chasing new highs.”

It remains unclear exactly what triggered the recent selloff. There is a saying in investing — bull markets climb a wall of worry. Given the rapid price rally, it is likely that nervousness gripped the market. Hansen said gold’s recent failure to break through $4,380 resistance “probably helped change the mindset” from greed to fear.

He summarized what happened.

“What followed was a classic rush towards an exit too narrow to cope with the sudden burst of selling from technical-focused leveraged traders and recent buyers finding themselves underwater. The latest price action once again underlined the importance of liquidity differences between gold and silver, with the latter seeing liquidity that is roughly nine times lower than gold’s. These disparities magnify both rallies and corrections: a surge in buying quickly runs into limited supply, and any shift toward profit-taking produces outsized percentage moves.”

He noted that gold and silver recovered modestly in Asian trading after the big selloff on Tuesday, before resuming their slide during the day on Wednesday, indicating that Western investors were driving the correction.

Hansen said Saxo Bank maintains its bullish outlook for both gold and silver in the coming year.

“Following a much-needed correction and consolidation, traders will likely pause for thought before concluding that the developments driving this year’s historic rallies have not gone away — and will likely continue to offer support to metals that are no longer overbought but remain under-owned in portfolios.”

In a seismic shift, Morgan Stanley CIO Michael Wilson recently came out with an investment strategy that includes a 20 percent allocation to gold, and the idea has started to gain traction across mainstream financial networks.

Pushing precious metals allocations to 20 percent will require a lot of additional buying. Currently, investors with “significant” allocations to gold don’t generally hold more than 5 percent in their portfolios.

This leaves plenty of room for additional investment demand.

And in the silver market, a shortage of metal drove recent price gains. While some of this pressure was relieved by moving silver from New York to London, this didn’t alleviate the fundamental problem — demand exceeds supply. There isn’t enough metal. And you can’t print silver.

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