Gold meltdown comes with a currency chaser

The gold price is continuing to melt, but there may be some exchange rate upside for local investors.

Summary: After 12 years of price growth, gold is in a holding pattern and likely to ease back further in US dollar terms. Gold investors have been reducing their exposure over recent times, and some analysts are predicting a sharper fall. But a fall in the Australian dollar against the greenback would convert to a higher domestic gold price.
Key take-out: Gold has a unique role as an investment class on its own, removed from government monetary manipulation and is a potential beneficiary of currency movements.
Key beneficiaries: General investors. Category: Portfolio management.

On cue, for Eureka Report readers at least, a major correction in the gold price has started with an expectation that it will fall much further as support for the metal dries up, major holders cut their exposure, and investors rotate out of low-yield safety assets into higher-yield riskier assets.

How far gold will drop is a guessing game, though Japan’s Nomura Securities is forecasting $US1025 an ounce in the next six months, down 35% on its latest price of $US1581/oz.

Nomura is at the extreme end of gold forecasting but not alone in tipping a further substantial fall in the price, which has been under pressure since late last year when a mood-swing was detected among delegates to one of the world’s major mining events, London’s Mines & Money conference.

It was at that gathering of more than 3,000 delegates, many with close links to goldmining companies and gold investment funds, that I formed a view which led to a December 10 story in Eureka Report headed: Gold warning bells chime, and the equally prophetic first four words: “Gold is in trouble”.

Looking back, and both the headline and body of the story were an accurate prediction of what’s unfolded, because since publication the gold price has retreated from $US1712.50/oz (the December 10 afternoon fix on the London bullion market) to around its current $US1581/oz.

To put that 7.7% decline into perspective, it should be compared with the 10.4% rise in the All Ordinaries Index over the same time period, which also includes last week’s stockmarket correction.

Source: Bloomberg

On the Australian stockmarket the decline of gold can be measured by the 16% fall in the gold index, or the sharp falls by the top five ASX-listed goldminers. Newcrest is down 36% from its peak price last year, Regis is down 25%, Alacer down 64%, Evolution down 32%, and Medusa is down 35%.

The problem with gold is not that it has lost its appeal as a sheet-anchor in a balanced portfolio, or as an insurance policy against a collapse in other markets. That remains a possibility so long as Europe is stuck in a recession, the rate of Chinese growth is uncertain and the US continues to print money as an artificial aid to its recovery.

The real issue is that gold has enjoyed a 12-year bull market, propelled by safe haven investing, and that trend is coming to an end. This triggering a shift of funds, which will continue so long as there is confidence in a widespread global economic recovery.

Whether that confidence is well placed is the great unknown, but it is significant that some smart investors have been cutting their exposure to gold even if the world’s central banks are yet to react in the same way.

In recent weeks, George Soros and Mikhail Prokhorov, two of the world’s richest men, have made deep cuts into their gold exposure. Soros, through Soros Fund Management, sold 55% of its holding in the world’s biggest gold-investment vehicle, the SPDR Gold Trust, and Prokhorov sold his 38% stake in London-listed, but Russian focussed, Polyus Gold.

The Soros sale of 600,000 SPDR units in the December quarter, and reported on February 14, represented a transaction valued at about $100 million, based on prices at the time.

Prokhorov, who has a habit of correctly picking market trends, raised $US3.6 billion in two transactions, which saw his stake in Polyus pass to two fellow Russian oligarchs.

In 2008, Prokhorov picked the peak of the nickel market with a $US7 billion sale of a 25% stake in Norilsk Nickel.

Two men do not a market make, but Soros and Prokhorov are not alone in trimming their exposure to gold, which has been in a downward trend since hitting its all-time high of $US1900/oz in late 2011. The current price gold is down by close to 17% from its peak.

The decline accelerated late last year, producing a technical signal called a “death cross”. Chartists believe this could indicate a faster fall over the next six months because it shows the 50-day moving average gold price dropping below the 200-day moving average.

Whether it is by charting, or by analysing fundamental supply and demand trends, or the investment decisions of rich men, there is a pattern that indicates the end of an exceptionally long bull market for gold. This was reported in that December 10 article, and which deserves a fresh airing with the most important paragraphs being:

  • “Just as low-yield government bonds are starting to lose their appeal in favour of higher-yielding equities, so does gold risk being exposed as an investment with no yield if held in its physical form, or minimal yield if held through low-dividend paying mining company shares”.
  • “This means that now might be time to trim exposure in case a recent weakening becomes a sharp correction”.

On cue, the sharp correction has started, though I will be sticking to a view expressed in December and not sell the balance of the gold in my portfolio. This reflects the metal’s unique role as an investment class on its own, removed from government monetary manipulation and a potential beneficiary of currency movements.

Long-term gold bulls, such as the big Swiss Bank Credit Suisse, have turned against gold. The head of its precious metals research department in London, Tom Kendall, told London’s Financial Times newspaper last week that “gold is struggling to find the marginal buyer right now”.

What becomes interesting for Australian investors, and it’s a potential event I am watching closely, is what happens if/when the Australian dollar begins its long predicted, but slow to arrive, decline against the US dollar?

Investing for a currency gain is about as tricky as investing in the hope of a takeover bid, but there are two interesting points to consider with gold and the Australian dollar.

Firstly, the Australian dollar has sometimes been treated as a “gold currency” because of the country’s big goldmining industry, and at times the value of the dollar and gold have moved in harmony.

Secondly, a fall in the Australian dollar does wonders for the domestic gold price, as these examples show:

  • Today, with the Australian dollar at roughly $US1.03, a gold price of $US1581/oz converts to a domestic gold price of $1534/oz.
  • If the Australian dollar retreats to US90c, which some analysts expect, the domestic gold price rises to $1756/oz.
  • At US80c, the domestic gold price rises to $1976/oz.

Source: World Gold Council

The currency effect can be so powerful that some gold investors are hanging on to their gold for the currency effect alone, looking forward to the day, as are most Australian farmers and other exporters, when the Australian dollar retreats back to US70c – and the domestic gold price rockets up to $2258/oz.

It is the multiple factors influencing the gold price, from supply-and-demand to central bank inflation and interest rate targets, to currency fluctuations, which underlines the point about gold being in a class of its own and one of the few truly global investments.

Am I a buyer or seller? Neither. I see gold in a holding pattern, doomed to fall in US dollar terms – but matched by a corresponding (and overdue) fall in the Australian dollar.

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