Gold will stay glittery

September 27, 2011: 10:31 AM ET
gold prices

Click chart for more on gold prices

NEW YORK (CNNMoney) -- Gold officially lost its status as a safe haven last Friday, when the precious metal inked its sharpest drop since 1980.

The recent sell-off in gold prices moved the yellow metal below $1,600 an ounce, a roughly 15% drop over two weeks.

Several traders and industry watchers say gold's sharp correction was largely due to hedge fund and other money managers amping up their cash holdings in anticipation that investors may start asking for cash back, raising the threat of a flood of redemption requests.

"Whenever you have a market correct as quickly as gold just did, you can assume people are getting margin calls," said Wayne Atwell, managing director at Rodman & Renshaw, who covers the precious metals market.

Since much of the pullback came from money managers selling gold for more cash, analysts and investors say gold will remain volatile but the price shouldn't fall much farther.

Big hedge funds are getting slaughtered

Although money managers have been selling large swaths of gold, retail investors don't appear to be looting their gold holdings.

Exchange traded funds like SPDR Gold Shares (GOLD), iShares Gold Trust (IAU), ETFS Gold Trust (SGOL) and iShares Silver Trust (SLV) have not been selling into the broader market, according to Frank McGhee, head precious metals trader at Integrated Brokerage Services.

"To me, that's one of those on the ground indicators that the run-up isn't done, and people still want to hold gold," said McGhee.

Indeed, the creation of these ETFs, which give retail investors easy access to precious metals, have been among the factors fueling gold's sharp rise over the past decade.

Gold is still up over 95% from the beginning of 2007, when it traded near $800 an ounce. Meanwhile the S&P 500 is down 22% during the same time period.

Among the other reasons gold could retain its luster: central banks have become net buyers.

"Developing markets have been using gold as a way to diversify their holdings," said Juan Carlos Artigas, investment research manager at the World Gold Council. "Many central banks had many of their foreign reserves based in U.S. dollar, so they had a lot of exposure to whatever is happening in the U.S."

Whatever happens in Europe, it's unlikely that the need to diversify holdings will abate, and gold is a relatively safe way for central banks to do this.

Copper prices are getting killed.

Where other metals, such as copper, have primarily industrial applications, gold can serve many masters. It can be used as a currency while also seeing demand from industrial products. (There are flecks of gold in Apple's (AAPL, Fortune 500) iPhone.) Gold's hybrid role gives investors more reasons to continue to buy the metal in up and down markets.

"You can walk into a bank anywhere in the world with gold and get any currency in the world," said George Gero, a senior vice president at RBC Wealth Management. "Gold maintains its purchasing power, but this volatility is unprecedented."

Even if gold continues to move up, analysts say that volatility -- in all markets -- is here to stay.  To top of page

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