September 18, 2010

The Luster Is Back

Gold has been “back in the game” so to speak for a good decade now; in fact, it’s not just been back, the price of Gold has increased almost 4-fold since 2000 - not bad at all compared to the otherwise “lost decade” of investment returns.

Spot Gold – Monthly Chart

This week alone, there were three new all-time price records for the shiny metal.  The big impetus for the near $30 price jump earlier this week was the news that central banks would be net buyers of Gold for the first time since the late 1980s, purchasing about 15 tons of bullion this year.

Spot Gold – Daily Chart

Perhaps equally important is the fact that some of the biggest central banks have slowly phased out their sales of gold bullion while only the IMF was seen as a net seller of Gold recently. In the past decade, central banks have sold 442 tons of gold on average each year but the massive off-loading has stopped in recent years.  That may be one explanation why there is some sentiment of “this time is different” in the Gold market.


On the corporate end of the market, most commodity producers are typically net sellers in the futures markets as well, often using automatic hedging programs as part of their corporate hedging strategy.  This week however, Anglo Gold Ashanti, the world’s biggest gold miner, announced that it will wind up its hedging program and stop forward gold sales by 2011.  Other gold producers will certainly follow suit, if they haven’t done so already and that may have been the second impetus for a continued rise in the gold price this week.

From a global macro perspective, there may be a few other rationales as to why the price of gold may increase further still. First off, there aren’t many alternatives in terms of bullish market sentiment; as one trader recently put it: “Where else can you put your money these days?”  Investors are still scared of a potential double-dip.  You can sense a fear of a follow-up recession on the one hand on the other hand, capital is longing for yield in an environment of negative real interest rates. The thirst for yield has been a huge factor leading investors to look elsewhere, often towards emerging markets or, as in this case, towards Gold.

Then there is the ongoing argument about inflation/deflation.  While Gold’s record as an inflation hedge has been rather mixed historically, the inflation argument has been a huge factor spurring investor demand.  The peak price of Gold in 1980 is somewhere between $2100 - $2300 when adjusted for inflation.  Therefore, one should not be surprised to hear estimates of anywhere between $1500-$2000 as price targets for the next 6-18 months.  Some of the most vocal Gold bulls have called for a price target of $5000 within this decade.

Conflicting signals most everywhere you look while Gold has been a sort of sacrosanct in all this. And yet, what are the long-term prospects of holding Gold as an investment?

Although most financial analysts may have a good laugh about this, one should not discount the emotional aspect of an investment.  There is an undeniable feel-good factor about Gold.  Most investors would hold Gold not as bullion but in form of Gold certificates, Gold futures or one of the many other forms of non-physical Gold investments such as ETFs. But despite that, an investor may get a sense of security and comfort from investing in a commodity that is sure to outlive most government policies.

It is exactly that mistrust of governments and their apparent inability (across all party lines) to balance budgets which is yet another factor for the flight towards safety.  That flight has been most apparent in the US recently. A good indicator for that has been the renewed flight out of the US Dollar.


Indeed, US Dollar weakness explains some of the recent price rises of the shiny metal. Gold in Euro terms has had its peak at the beginning of this summer in the aftermath of the Greek sovereign debt crisis.  Since then, the rise in Gold has not been as pronounced when expressed in Euros. The €1,000 level for Gold would seem like an important testing ground for Gold prices to move higher in the near-term.

Gold Price in Euro (Daily Chart)

Longer-term price targets are more illusive and certainly harder to asses. Keeping in line with the Gold versus currency theme, yet another measuring stick might be the Australian Dollar.  Often called a “commodity currency” itself, the Aussie Dollar may be another indicator for the true price of Gold. From that perspective, the recent rise in Gold is even less pronounced and over A$1,000 below the all-time high in early 2009 during much gloomier times in financial markets. While the long-term trend is certainly bullish still, we need to see “higher highs” rather than descending highs on the upside (yellow highlights in the chart below).

Gold Price in Australian $ (Monthly Chart)

So then, should you keep your money in US denominated assets, in Gold or in other currencies? 

Although I advise caution when considering Jim Cramer’s recent call that “all” investors should have 10% of Gold in their portfolio, an allocation of Gold as part of a diversified portfolio certainly makes sense for some investors - slightly more sense for US$ based investors. Despite the massive bull run during this decade however, Gold in itself is a “non-yielding” asset which means it does not provide any returns other than price appreciation. In fact, there is a cost associated with holding Gold (e.g. the Gold ETF “GLD” has an expense ratio of 0.4%) and that has to be considered when assessing the time frame for holding Gold.

The comparison is not perfect but you may consider Gold similar to an investment in non-dividend paying stocks (rest assured that Gold prices would never fall to zero though).  The commodity component of Gold however, can make prices quite volatile and that is something every investor has to weigh-in as well.  While equities provide no relief in terms of smoother returns these days, you could still make the case of assessing the yield factor.  From that perspective, high-yielding currencies like the Australian $ with about a 4% interest rate differential to the US Dollar may be an option.  In terms of volatility, the ride in Aussie Dollars has been just as bumpy as the ride in Gold (see volatility comparison below).  Purely from a yield perspective then and granted you are comfortable with the “bumpy ride”, the positive yield in Aussie Dollars does look very attractive.

30-day Volatility: Sep 18, 2007 – Sep 17, 2010
Chart courtesy of:    GLD = Gold ETF  FXA = Australian $ ETF

In terms of investor demand, allure and price sentiment, the shiny metal appears to have all the qualities that keeps it a “hot” commodity.  Without calling any price targets, rest assured that it will be an interesting ride ahead.  Buckle up and enjoy the ride...

Good luck and good investing!

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