Gold in the cold

As global analysts suggest zinc, tin and diamonds will lead a wider resources recovery in 2014 (see Tim Treadgold today Prepare for a resources rush), the gold price is moving in the opposite direction.

This week, the gold price is testing the key $US1,200 support barrier for the second time in six months as an increasing number of retail investors exit their holdings in exchange-traded funds (ETFs).

Despite a defiant bounce mid-week, the yellow metal fell 1.4% to $US1,226 an ounce overnight, reiterating a warning for those investors with exposure to the asset class as gold nears its first annual capital loss in 12 years. This followed a 2.7% fall on Monday – the biggest drop since the beginning of October.

Many traders believe falling below the $US1,200 barrier (the red line ) could see the gold price dive to $US1,000 – the next big support level – in a flash (the green line), as illustrated in the chart below.

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This would take gold back to prices last seen between 2007 and 2009 – during the GFC – where it broke through $US1,000. But the environment is completely different now to what it was back then. Whereas many retail investors fled in panic to gold– and moreover, gold ETFs – amid tumbling equity markets in the wake of the GFC, they are now only beginning rotate into the equity market.

More ETF holders are recognising the improving economic sentiment and conditions. The potential of increased inflation from the US Federal Reserve’s so-called ‘quantitative easing’ program hasn’t eventuated, to which gold supposedly acts as a natural hedge. Further, the Federal Reserve is almost certain to begin cutting back the program at the beginning of 2014.

As a result, known ETF holdings across the globe (particularly in the US) have been falling faster than the gold price in the second-half of this year, shown below.

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This is a bad sign for the gold price as net inflows or outflows of gold ETFs hold a huge amount of influence. Invented just after the GFC, gold ETFs made exposure to gold more accessible to fearful investors, who swept in en-masse on the ‘safe haven’ asset, propelling the gold price by more than 140% to $US1,900 an ounce in September 2011.

Interestingly, in Australia, some investors are still holding onto ETFs compared to the rest of the world. ETFS Physical Gold (GOLD), an ETF listed on the ASX by ETFS Metals Securities Australia (GOL), has been tracking above the gold price since April this year (see below). But this may be linked to the Australian dollar’s fall from grace (the currency has slumped 14% from $1.05 since April), as the gold price is measured in US dollars.

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So why does all this matter – even for those not directly invested in the yellow metal?

A fall in the gold price, particularly back to the $US1,000 mark, is a clear signal that the fear that once dominated global markets is dissipating. When retail investors decide to sell off their holdings in gold completely, this means they believe the economic recovery is real and will last. In this environment, there’s little need to hedge.

It also indicates the US dollar may begin to rise again. Many investors substituted the world’s reserve currency for gold after the GFC – so they often move in opposite directions. A rising US dollar and falling gold price spell no immediate danger to inflation, despite all the money printing underway in the US and Japan.

However, the possibility does still exist that gold could regain its sheen. The gold price is notoriously difficult to forecast, as other vital factors such as its strong physical demand (especially in China and India) comes into play, with many economists arguing that gold’s traditional ‘store of value’ will always be relevant.