All that glitters: has gold lost its shine?

The price of gold dropped significantly in mid-April, plummeting to $1322 an ounce – its lowest price in decades. Since then it has regained a large portion of those declines, and at the time of writing the spot price was hovering around $1400 an ounce.

“At some point we are going to hit an iceberg despite the central banks’ effort – that is when gold is going to shine.”

Angelos Damaskos

News of the heavy fall would have had concerned investors worried about gold’s traditional role in a portfolio as a hedge against rising inflation and a declining US dollar. Others meanwhile, would have been more sanguine, viewing it as a temporary blip rather than a fundamental crisis.

Gold had been in a raging bull market since the turn of the century, rising for 12 consecutive years before it reached a high of $1923.7 in September 2011. A fall, or correction, had therefore been on the cards for some time and experts argue it was mid April when the gold price reached some key technical points which pushed it into official bear market territory.

According to Marcus Grubb, strategist at the World Gold Council (WGC), the precise tipping point for the price plummet was a very large futures trade on 12 April. “In April you saw a complete reversal in the positioning in COMEX, the largest gold futures market, a big increase in the short position and a decline in the net long – now that position is the most bearish since the late 1990s,” says Grubb.

But the broader technical drivers included the pick-up in the US economy and the Fed hinting it would be reeling back quantitative easing (QE) later this year, continuing weakness in Europe and accelerating its QE programme. The plight of Cyprus also fed into the story as reports circulated that the beleaguered nation would have to sell some of its gold reserves to help fund its debts and other nations might follow suit. This led to institutional investors with more tactical mandates taking money out of gold, particularly gold exchange traded funds (ETFs), in favour of other more cyclical and risk asset classes such as US and Japanese equities or high yield bonds. Grubb says since January gold ETFs lost 450 tonnes from a total of some 2700 tonnes in all ETFs – the biggest redemption since the first gold ETF was launched in 2003.

Outflows

The gold market is in an interesting situation whereby there is a wall of demand for the physical asset at the same time as speculative investors are sitting on large futures positions and therefore capping the gold price.

According to Grubb, premiums are very high in Mumbai and Shanghai, yet investors are exiting ETFs as a result of the reported recovery in the US and expectations of tapering QE.

Demand growing

The WGC’s latest trends report revealed total jewellery demand was up 12% year-on-year in Q1 2013, driven in the main by Asian markets. Jewellery demand in China was up 19% on the same period last year and stood at a record 185 tonnes. Demand in both India and the Middle East was up 15% respectively and in the US, demand showed a significant increase, 6%, for the first time since 2005. It also found bar and coin sales were up 22% year-on-year in China and 52% in India. However, gold held by gold-backed ETFs, which in 2012 accounted for 6% of the world’s gold demand, fell by 177 tonnes over the period (see The Big Picture).

Gold investors fall loosely into two categories: short-term investors investing for tactical reasons; and longer-term buy-and-hold investors, like institutions. In addition, there are four main ways to access gold: through exchange traded products (ETPs); buying gold shares such as mining companies; physically owning gold through coins or bars; and the gold futures market.

Access

Investing in physical gold through ETPs appears to be the main way investors are accessing the precious metal. But experts are quick to point out investors should use gold ETPs that are physically-backed rather than backed by futures returns because in the event the fund is liquidated then the investors still has a claim on the underlying bullion – and they are more liquid.

Indeed, physically holding coins or bullion is problematic in that investors often tend to pay a big premium over the spot price of gold and it is not as liquid. An investor would have to physically get their coins and store them in a vault at a bank, which has a cost attached. Another way is through gold futures although experts say this method tends to be the preserve of shorter term investors looking to play on leverage.

Digging for opportunities

The other method is through gold mining stocks, although this is seen to be more a pure equity play as stocks such as gold miners have a high correlation with the wider equity market. It affords some exposure to the gold price, but more often to broad equity market beta so investors are not diversifying in any substantial way.

“I would argue that is a decision about how you allocate your equity holdings. Gold miners will not buffer a portfolio against risk events like gold will,” says ETF Securities head of research and investment strategy Nicholas Brooks.