MARKETS SPECTATOR: Avoiding a golden temptation

If you think the 18 per cent fall in the price of gold this year represents a good opportunity to buy bullion, think again says Credit Suisse analyst Tom Kendall.

Gold was trading overnight in New York at $US1,391 an ounce. Kendall thinks the price of bullion will fall further based on analysis over a very long time period.

Over 150 years gold’s average price is $US520 an ounce, according to Kendall. Since 1971 when the US dollar’s value was linked to gold ended, bullion’s price has been on average $US780 an ounce, he says.

In the eight-year period after gold’s link to the US dollar ended, gold surged by 875 per cent to $US1,750 an ounce in 2007’s real terms, says Kendall. But then the price of over two-and-a-half year gold dropped 60 per cent, he says.

The Credit Suisse analyst suggests that a 60 per cent fall after the 2005 to 2011 bullion rally is possible. That would send gold to $US1,000 an ounce by the end of the first quarter 2014, says Kendall. The drop in the gold price to that level is possible because there is no marked acceleration in inflation, the euro shows no signs of collapse, exchange traded funds are dumping their gold holdings and central banks are not selling their gold reserves.

Gold is often used as an inflation hedge. Kendall thinks even with central banks printing money will be hard for the world’s major economies to generate 2-4 per cent increases in the consumer price index.

There was some talk gold was a good buy as insurance against a collapse of the euro. But Kendall says the recapitalisation of European financial institutions and the commitment by Mario Draghi and his counterparts at other central banks to “do whatever it takes to preserve the euro” has averted a collapse for now. The Cypriot crises did not trigger a mass flight out of the euro and into gold, says Kendall.

Exchange traded funds have cut their gold holdings by 435 tonnes this year, according to Kendall. If the US Federal Reserve signals a reduced rate of quantitative easing before year end, as expected by Credit Suisse, then the ETFs may sell a further 435 tonnes of bullion, putting further pressure on the gold price.  

Before quantitative easing, in early 2010 gold traded at between $US1,050-$US1,200 an ounce, according to Credit Suisse.

Gold producing central banks such as Russia and Kazakhstan, while not sellers of gold, are not buyers either, says Kendall. The last major purchase of gold by a central bank was by South Korea, which bought 20 tonnes in February this year, according to IMF data.