As I wrote this post on April 15, spot gold prices, according to Bloomberg, settled down approximately 9% for the day (which marks the biggest one day decline since February 1983), while spot silver prices were down approximately 12% for the day. Other precious metals, and industrial metals for that matter, have not escaped the recent downward pressure on commodity prices as platinum, palladium, aluminum, and copper also posted losses on April 15. It is worthwhile to note that other energy and agriculture commodities were also down for the day.
However, it is gold that is at the forefront of most investor mindsets and the lead story on many financial programs. This should not be surprising given the widespread attention that gold, and to a lesser degree silver, has received from investors since the great stock market meltdown of 2008 and early 2009. Gold has long been viewed as a potential inflation hedge within an investment portfolio.
However, inflation has been largely benign in recent years despite the attempts of the Federal Reserve to stimulate the economy through their own inflationary measures. Despite this, flows into gold, and gold-related investment strategies, continued to increase over the past few years, in my opinion, for the following reasons:
- With the advent of Exchange Traded Products (ETPs), adding gold exposure to an investment portfolio is now more convenient and less costly for institutional and retail investors.
- Many investors believe that the actions of the Federal Reserve have introduced tremendous inflationary pressures into the system and have added gold to their portfolios in advance of the realization of those inflationary pressures.
- At Hennion & Walsh, we tend to view investments in precious metals; gold in particular, not only as a potential inflation hedge but also as an equity market volatility hedge -- the latter in a similar fashion to the way that investors traditionally have gravitated toward fixed-income investments (i.e., U.S. Treasuries) when equity markets are volatile or depressed. Hence, when equity markets volatility increases, or the perception that equity markets volatility will increase, additional flows can be expected into gold investment strategies.
With this as a backdrop, the recent significant downturn in gold prices has been blamed by many on the following:
- Following reports that Cyprus may be selling 400 million euros worth of its gold reserves to help finance their own fiscal problems, many are concerned that other European central banks will begin to sell-off their gold positions to better position themselves to fortify their own sovereign balance sheets. (Our take: A likely contributor but perhaps with a bigger influence on institutional investors than retail investors.)
- Investors are either regretting their decision to not jump into the stock market bull run earlier or are growing less concerned with their nearer team inflationary outlook given continued, lackluster U.S. and global economic growth. Either way, investors may be using the current downturn in the commodities market to re-position themselves into equities. (Our take: A likely contributor but not with the same short-term, immediate impact as No. 1 above.)
- Analysts have been suggesting for years that certain commodity prices, gold in particular, have risen too high and are due for a pullback. As a result, recent events may be causing some of the more recent gold investors to take profits or exit the precious metal altogether. (Our take: A likely contributor as well but investors should be put this recent drop in perspective as gold returned approximately 7% for 2012 according to Reuters, and by so doing, extended its own bull market run to 12 consecutive years.)
- China GDP growth for the first quarter of 2013 slowed to an annualized rate of 7.7%, below the consensus estimate of 8%, and down from an annualized rate of 7.9% in the fourth quarter of 2012. Such growth levels, while impressive relative to other developed market economies across the globe, spurred concerns that the U.S., and other markets with ties to the prowess of the Chinese economy, may not be able to count on the "China Effect" to help propel their own economies forward in 2013. (Our take: While this is likely an investor concern, it would presumably have more of an impact on industrial metals, such as copper, as opposed to precious metals, such as gold.)
While it is too early to tell how far gold and silver will fall as a result of the domino effect that has currently taken hold of the commodities markets, we still believe that a client risk tolerance/investment objective appropriate allocation to precious metals is worthy of consideration. Investors will likely still look to precious metals to help not only from a diversification standpoint, but also to assist with total return potential given the record low interest rate environment that fixed-income investments find themselves within currently in the U.S. and potential future volatility in the equity markets.
For those investors will allocations to precious metals, this type of short-term price behavior can serve as a reminder of the type of volatility that commodities can experience. As a result, these investors may want to revisit their utilization of commodities, including gold and other precious metals, and feel comfortable with their existing investment allocations to this asset class. On the other hand, for those investors who do not have an allocation to precious metals in their portfolios at present, this pullback -- once complete -- may present an attractive entry point for a longer-term investment time frame.
Disclosure: Hennion & Walsh Asset Management currently has allocations within its managed money program to exchange-traded product (ETP) named PowerShares DB Precious Metals Fund DBP.