Losing its lustre?

Gold shifts from an easy “buy-and-hold” asset into a short-term trading situation.

Summary: Changing conditions in the gold market have left investors in a quandary, especially those who thought that buying shares in gold producers or explorers was the same as owning physical gold. When pump-priming in the US ends, gold will be under pressure from the competition of alternative, interest and dividend-paying, investments.
Key take-out: Gold forecasting fraught until global economic direction becomes clearer.
Key beneficiaries: General investors. Category: Commodities.

If Ben Bernanke doesn’t understand gold prices why, as chairman of the US central bank, is he sitting on 8133.5 tonnes of the stuff? The answer is that he doesn’t have to understand the price, all the US has to do is retain ownership, and gold will do the rest.

Bernanke’s startling admission last week in evidence to the US Senate Banking Committee that: “Nobody really understands gold prices and I don’t pretend to understand them either” was one of a series of significant recent events in the gold market.

The others were:

  • A rush by Asian buyers to soak up gold offloaded by western world investors, and
  • A change in the investment case for gold with the long-term buy-and-hold strategy which has worked well for 13 years, giving way to a short term trading situation.

Changes in the gold market, which is driven by multiple and often conflicting forces, have left investors in a quandary, especially those who thought that buying shares in gold producers or explorers was the same as owning physical gold.

Investing in gold, or in miners?

What the share buyers have discovered, to their cost, is that exposure to gold through a goldmining company magnifies the variables and introduces the potential for human error. That is what happened to Australia’s biggest gold miner, Newcrest, as it has crashed from close to $30 as recently as October last year to around $12.27 today – with a brief dip to a multi-year low of $9.07 on June 25. The Newcrest wipe-out coincided with a sharp fall in the gold price to its own multi-year low of $US1180 an ounce (June 28) and confirmation from the company that it was suffering from production cost blow-outs and a forced reduction in annual output targets.

The dramatic speed of the share-price melt-down was compounded by ill-conceived private briefings of investment analysts which shattered confidence in management and triggered an ASIC investigation. Most other Australian gold mining companies have suffered similar, or worse, share price wipe-outs as the gold price has plunged close to (or below) their cost of production with widespread pit closures and staff redundancies.

Graph for Losing its lustre?

Source: Bloomberg

While the savage setback for gold miners has taken most observers of the industry by surprise it is reminder of a why gold works best in an investment portfolio in its purest form; as a metal (which doubles as a currency).

A pure investment

In other words, the best exposure to gold as I have been saying for several years is in the same form enjoyed by Bernanke and the US Government where any pretence in understanding why and how the gold price moves is not required because buy-and-hold works well if you have the financial staying power to lock it away for decades.

Not everyone has the luxury of time measured in decades when managing their investments, and not everyone is happy with their investment in physical gold because it does not pay interest but does incur storage charges.

Cold comfort as it might be the sharp correction in the gold price since late last year has been well telegraphed to readers of Eureka Report, most significantly on December 10 (Gold warning bells chime) when it was noted that: “Gold is in trouble. For the first time in a decade the case for owning physical gold is weakening, and the case for investing in goldmining companies is collapsing”.

Where to next?

Well, the collapse has come and while it would be comforting to think that the worst is over there might still be one more downward leg in the gold price before the all-clear can be sounded.

One-time supporters of gold, including the Swiss investment bank, UBS, have turned bearish, and the US investment bank, Goldman Sachs, sees the long-term trend pushing the gold price down to $US1050/oz by the end of next year.

Before getting to that low point Goldman Sachs sees gold trading in a range, averaging around $US1300/oz between now and the end of 2013 before falling sharply again next year.

Other observers are more optimistic. Analysts at the stockbroking firm of RBS Morgans see gold recovering above the $1400/oz mark.

Whatever the outlook it seems certain that gold will not be moving in a straight line up, or down with significant price swings of up to 10% either way, creating trading opportunities during this tug of war between buyers and sellers.

Some gold bulls who acquired the metal before the sell-off started in October, 2011, will use periods of price recovery to par back their losses.

Traders will play both sides and new long-term entrants, especially those in countries with spare cash and a gold-buying habit (which today is mainly China and India) will soak up gold when it is permitted by government regulation.

Growing appetite for gold funds

Asian gold buyers are also developing a taste for “paper” gold held through tradeable gold funds with an overnight story from the Reuters news service reporting a net inflow of $33.5 million into Asian-managed gold funds in the three months to June 30, the same time when western-managed funds were seeing large outflows.

China has just approved its first two gold-backed exchange-traded funds which have attracted $US261 million, which was below expectation but does represent the start of a new market for gold.

Movement in the gold price over the past four weeks is a pointer to the future trend of rapid changes in direction with gold bouncing from a low of $US1180/oz on June 28 to $1340/oz earlier this week while the price over the past 24-hours has moved between a low of $US1319/oz and the latest price of $US1335/oz.

Mark Newton, chief technical analyst at New York-based Greywolf Execution Partners, told The Wall Street Journal that the rally in the gold price from its June low was: “the beginning of a longer-term bottoming process.”

One of the major factors at work in the gold market include central bank stimulus policies of the sort being administered by Bernanke. So long as he keeps priming the US pump with cheap funds and holds interest rates at emergency low levels gold will not do what Goldman Sachs fears and head too quickly for its forecast floor price of $US1050/oz.

But, when the pump priming ends gold will be under pressure from the competition of alternative, interest and dividend-paying, investments.

In the background, but very much in the Bernanke’s “I haven’t got a clue” category are the twin demons of inflation and deflation with both potentially driving the gold price one way, or the other.

Conclusion

So, the choice for gold investors today is to either treat the metal as a trading opportunity, to buy in the dips and sell in the recoveries or to accumulate small positions for locking away in a portfolio, just as central banks do.

Or, do what I’m doing and staying well clear of the gold market until a clearer picture emerges of the world’s major economies.

If recovery is indeed taking hold in the US, China does not suffer a hard landing, and Europe starts to revive, then gold will spend a long time on the sidelines – unless the inflation which Japan is trying to stimulate gets out of control.

If recovery does not take hold and the world starts to slide back into a crisis then gold could easily test its 2011 highs – which could be what Chinese and Indian buyers are betting on as they acquire the only currency/commodity that is beyond the reach of accident-prone companies (and governments).

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