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Even Another Cyprus-Style Crisis Can't Save Gold

Chris Ratcliffe | Bloomberg | Getty Images

Since the bailout deal was reached on Cyprus, the gold price has fallen. The decline suggests that gold is really in a weak position right now. I think the price is likely to fall further. Here's why.

The major global stock markets are doing really well this year: the S&P 500 is up about 10 percent, U.K. stocks are up about 1 percent in dollar terms and Japanese stocks up about 10 percent. Even with all the problems in Europe, the Euro Stoxx index is down only about 2 percent in dollar terms. By contrast, gold and silver are down about 5 percent. Platinum and palladium have also outperformed gold and silver. In fact it's hard to find any commonly held assets that have fallen as much as gold and silver.

Even government bonds, which yield almost nothing, have done better. So it's natural that a lot of people will be wondering, why am I holding gold when I could be making more money holding this other asset? That's probably why retail holdings of gold through exchange-traded funds have fallen 7 percent since peaking at the end of last year. Also professional positions in gold futures on the COMEX have fallen by 30 percent since peaking in October of last year.

(Read More: Investors May Hate Bonds, but They Keep Buying)

Why are people selling? It seems to me that there's been not so much of a change in the factors supporting gold as a change in investors' attitudes towards these factors, with one major exception.

One of the main factors supporting gold was the expansion of the U.S. Federal Reserve's balance sheet. As the Fed pumped liquidity into the U.S. economy following the global financial crisis, the gold price rallied. But that relationship started to break down late last year and this year the two have diverged completely.

Gold vs Fed's Total Assets

The Fed's balance sheet has kept growing, but that fact hasn't been enough to keep people buying gold. Liquidity is no longer driving the gold price, and more quantitative easing won't necessarily push gold higher.Another reason investors were buying gold was the fear of inflation. Last year the price of gold pretty much tracked the U.S. break-even inflation rate, the implied inflation forecast derived from the inflation-linked fixed income market. Even that relationship has broken down, even though similar inflation forecasts are rising around the world, gold is no longer rising in tandem.

The reason that investors are no longer buying in accordance with these theoretically supportive factors may be the euro zone. Gold is a hedge against financial risk in general as well as inflation or currency debasement risk. One of the main risks in the global financial system recently has been the possible break-up of the euro zone. But that risk is receding, as we can see from the average weighted credit default swap (CDS) rate for the peripheral European countries.

Gold failed to rally even when the peripheral CDS rate hit its high last June; added to that the fact that the CDS rate has basically been headed lower since then suggests that gold is losing the other main support that it has.

Gold vs GIIPS Credit Default Swap Rate

So gold is still tracking the risk of a euro zone crisis - that's the factor where people's views haven't changed – except that despite the recent debacle over Cyprus, the risk of a euro zone crisis is still estimated to be much lower than it used to be.

So overall it looks like the major supporting points for gold are no longer supporting the metal. Either they are no longer pointing upward, like the credit default swap rates, or they are but the market is ignoring them, like the Fed's balance sheet or the implied inflation rate. This strikes me as a fundamental change in the demand picture for gold and a big negative going forward. I expect the price of the yellow metal to fall in the next few months to $1,540, according to a continuation of the current technical downtrend pattern, with further support likely at $1,490.

(Read More: Monetary Policy Is Not Loose Enough: Fed Official)

The author is the Head of Global FX Strategy at IronFX, an on-line trading firm specializing in Forex, CFDs on U.S. and U.K. stocks, and commodities. He was previously Head of the Forex Committee at Deutsche Bank Private Wealth Management.