A gold mirage

The gold price has risen in recent days … but don’t be fooled.

Summary: Are the incremental rises in the gold price over the past few days a signal that the metal is in a recovery phase? There are various factors at play that have added weight to gold, but don’t bet on a big rebound – at least at the moment.
Key take-out: On face value, the gold price is up around $US23/oz over the past week. But don’t forget the exchange rate effect. The gold price in Australian dollars has actually fallen.
Key beneficiaries: General investors. Category: Commodities.

Gold hit a two-week high earlier today, but the rally to around $US1320 an ounce will probably be short term.

Fear about fresh Russian intervention in Ukraine, a sharp correction in technology stocks on US stock exchanges, and a hint that US interest rates will remain low for longer, drove gold to its highest price in two weeks.

But the fact that such significant political and financial events could only lift the gold price by around $US23/oz over the past week, or less than 2%, is a reminder that the underlying fundamentals for gold remain weak.

For most investors gold remains a confusing asset. It has recovered ground lost after last year’s heavy 28% price fall, but it is yet to show that the recovery will continue as every short-term rise is being countered by long-term selling pressure.

The precious metal, which plays multiple roles as a commodity, currency and collectible has enjoyed a number of short-term price spikes, such as that over the past 48-hours, while also remaining under long-term downward selling pressure.

That selling is best seen in the continued withdrawal of funds in gold-only funds such as the SPDR Gold Trust, the world’s biggest gold-backed exchange-traded fund, which saw another 2.7 tonnes of gold sold off this week.

In effect, there are two gold markets at work. There is a short-term trading market, which is heavily influenced by news of the hour, and a long-term investment market that is based on the overall trend in the global economy.

Over the past few days, short-term factors have dominated sentiment with speculators reacting to a flow of good news for gold as an alternative investment class that does best in periods of financial and political uncertainty.

The first gold-positive event this week was the release of the minutes from the March 18-19 meeting of the US central bank’s Open Market policy committee, which emphasised a position that a rise in official interest rates would not be warranted until sometime next year.

Gold is an extremely interest-rate sensitive asset because, in its physical form, it generates zero yield, rewarding (or punishing) investors by movement in its capital value.

Low interest rates mean that gold has an attraction as a safe haven investment beyond the reach of government monetary policy.

The second gold-positive event this week was the rise of tension in eastern Ukraine where pro-Russian demonstrators have taken control of some public buildings, potentially laying the groundwork for Russian military intervention in a manner similar to the earlier annexation of Crimea.

The Ukraine situation also took a turn for the worse when Russia threatened to cut off Ukraine’s supply of natural gas, which could also mean gas shortages across Europe.

The third gold-positive was the exodus from speculative technology stocks in the US, which saw the Nasdaq composite index fall by 3.1% last night, the biggest fall in three years. Investors moved funds into safe havens such as US Treasury bonds, a shift which helped the 10-year note slip lower by five basis points to 2.64%.

On their own each of those events – lower interest rates, the Ukraine situation worsening and a sell-off in the tech-sector – should have been enough to spark a significant rally in the gold price. But all they produced was a 1.7% rise – which was less than last night’s 2.3% rise in the price of nickel, or the 1.9% rise in the price of aluminium.

Australian-listed gold producers have enjoyed a mini-rally over the past week. Sector leader Newcrest has risen 10% to reclaim a price above $11. Northern Star, a popular smaller producer, has done better with a rise of 12%.

The dollar effect

But bearing down on the local goldminers is a negative factor that short-term investors appear to be overlooking, and that is the rising value of the Australian dollar. The higher $A is effectively eliminating the benefits of the rising US dollar gold price.

Over the past week, for example, the higher US dollar gold price has been totally lost on conversion to Australian dollar thanks to rise in the exchange rate from around US92c to US94c.

Last Friday, the official London gold price “fix” was $US1297.25/oz which, at the exchange rate of the day of US92c, produced an Australian gold price of $A1410/oz.

This morning, when the spot market gold price was around $US1320/oz (after peaking overnight at $US1324/oz), and the exchange rate was US94c, the Australian gold price was $A1404/oz.

What the gold price gave the exchange rate took away, with gold in Australian dollars actually falling by $A6/oz over the past week.

The exchange rate example is one of the short-term factors at work in the gold price and, more importantly, in the financial performance of goldminers with most of their assets in Australia.

The other short-term factors, such as events in Ukraine and the tech-stock sell-off in the US, will come and go, producing the sort of gold-price spike seen over the past week.

But the critical aspect to the short-term spike, and the first of two good reasons to treat the gold market warily, is that three significant events over the past five days have delivered a modest increase of around 1.7% in the gold price.

The second good reason to be wary is that the flow of gold into gold-focussed investment vehicles remains negative.

In other words, long-term gold investors continue to shift their funds out of gold into other assets classes which generate a yield, however small, leaving them positioned to take advantage of a widely anticipated global recovery – a glimpse of which might have been evident in the higher nickel and aluminium prices, two classic industrial metals.

Gold price forecasts remain widely divided. Leading investment banks such as Goldman Sachs are sticking with their bearish view of gold slipping to a cyclical low of $US1050/oz over the next few years.

Other market observers see the gold price rallying to $US1400/oz but, significantly, no-one apart from gold extremists (the so-called gold bugs) can see gold returning in the short or long term to its $US1900/oz peak reached in 2011.

As an investment class, gold retains its position, but not as a dominant asset in any portfolio. It is an insurance policy against troubled times, which inevitably pop up from time to time.

The next big event, which could re-ignite a serious upward move in the gold price, is an outbreak of inflation, caused by the excess money in the global financial system.

But until inflation displaces the current bogeyman of deflation, there is no need to top up your exposure to gold, or add it to your portfolio.

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