I love gold. It has had one of the best runs in the past 13 years. While the stock and bond markets tanked, gold went up like nothing else. From around $250 in 1999, it reached well over $1,800 at its peak this year.
There are four factors that helped the rise of gold:
- A period of sizable inflation (particularly in the commodity prices) from about 2002 to 2008.
- A period of uncertainty in the global markets (2008 to the present), including the financial crisis of 2008 and the eurozone troubles in Greece and elsewhere.
- The introduction of gold ETFs that allowed investors in the developed markets to bet on the yellow metal.
- The growth in India and China, where consumers got more prosperous over the past decade and bought a lot of jewelry. In fact, China is now the world's biggest consumer of gold.
Medium-term performance of GLD:
Click to enlarge
Source: Yahoo Finance
However, I believe gold's honeymoon season is over and it could face significant downward pressures in the next few months. The following chart from the World Gold Council's Q1 2012 report paints a picture of weak demand (look at the negative values in the highlighted portion of the chart).
Source: World Gold Council
I detail below the reasons why gold could go down:
- The Asian jewelry market is slowing down. The World Gold Council reported that the markets all over Asia are seeing a drop in jewelry demand (India -19%, Saudi Arabia -17%, Thailand -8%, Turkey -16%, Vietnam -10%).
- The use of gold by industries fell 10% Q1 2012 (y-o-y), amounting to 10 tonnes of reduced gold consumption. The electronics industry is a major consumer of gold and the overall weak sales there will further reduce gold demand.
- The rise in gold prices has prompted explorers around the world to prospect even more keenly for gold reserves. Mining production has grown 5% this year, due to the renewed efforts in gold exploration.
- In India, the fast rise in gold prices, coupled with a drop in the rupee and the slowdown in the Indian economy, has priced out most of the middle class from buying gold. Bloomberg reports:
On the National Spot Exchange Ltd., India's biggest bourse for physical metal contracts, demand for gold and silver fell by about 20 percent to 25 percent this year because of higher taxes and prices... Everybody is selling. Even retail investors, who had invested at lower levels, are sellers right now...Gold demand in India fell to 207.6 tons in the quarter ended March 31 from 290.6 tons a year ago.. Investment demand dropped 46 percent and jewelry demand fell 19 percent
- While Mexican and Russian central banks are busily adding gold to their portfolios, the demand from other central banks is dropping. In Q1 2011, the demand was 137 tons, while in Q1 2012, it was a little more than 80 tons.
- Inflationary pressures across the world have receded. Gold is typically seen as a hedge against inflation and normally tracks inflation in the long run. With the slowdown in the Indian and Chinese economies, along with the ever-increasing bad news flowing in from the eurozone, inflation fears have quickly evaporated from investors' minds. Demand is expected to lag behind supply in most of the world, including in the emerging markets.
- The Indian wedding season, which makes for one of the largest consumption periods for gold, is over and June-September is typically a dull season for the gold industry in the country. The seasonal factor is expected to put pressure on gold in the short term.
- Chinese gold consumption growth is also falling as the major cities in the country reel from the economic slowdown. Though the growth is still positive, it is probable that Chinese consumers might follow the path of their counterparts in the rest of Asia.
Thus, I'm bearish on gold now. If the Greeks were to quit the euro, gold could face a short-term bull wave, but in the long run, I believe the gold fundamentals are weak to support the current prices.