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We are a team of two professional investment analysts working for a well established Investment Management firm in the City of London. James@fundgurus - I have worked for a number of years in the Investment industry gaining experience from a range of different avenues. Starting my career out as... More
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  • Has Gold Only Just Begun Its Long Journey Downwards? 0 comments
    Apr 15, 2013 3:25 PM | about stocks: GLD

    Gold headed lower today after Goldman Sachs, Deutsche Bank and SocGen downgraded their outlook for the commodity last week. Since the start of 2013, gold has continued to be out of favor as investors begin to move into more prosperous investments. Equity markets took the lead as the S&P 500(NYSEARCA:SPY) reached record highs amid a sea of global loose monetary policy that spurred investors into real assets.

    Over the last few weeks we have seen a number of global issues, first from Italy, then Cyprus and more recently North Korea provoking its neighbors and the US. Usually gold would have reacted positively to this spurred by investors seeking a safe haven for their money, however as investors become more confident in equities this necessity to hedge risk through gold has diminished.

    Gold is treated by many as its own asset class, and with good reason. The precious commodity has shown very strong correlation over the past to a number of things. One of which has been confidence and optimism in global markets. Many would use gold as an emotional hedge, but as we have seen recently when people become more optimistic, downward pressure starts to mount.

    Friday saw gold fall below $1,500 an ounce for the first time since mid 2011 as central bankers urged investors to move into currency and equities as the economic outlook brightened. This was not the only reason behind this fall, last week the European Commission said Cyprus had committed to sell around $520m worth of gold which would be used to cover losses from recent emergency loans to the country.

    Earlier this year a few big names (George Soros) began unwinding large positions within hedge funds from the SPDR Gold ETF(NYSEARCA:GLD), prompting a number of other investors to follow suit. The introduction of gold ETFs in the mid 2000s has made this commodity very accessible to the retail and institutional investors and now this market makes up a significant proportion of the traded volume which can be both a good and a bad thing. If a sell off does gather pace, we could see sharper drops in the price of gold more than what we are used to, and this has been evident from selling on Friday and Monday.

    (click to enlarge)

    There are some buyers still out there, many central banks have been building up their reserves and 2012 saw the largest increase in demand since 1964 as the net was cast wider to include emerging market countries such as Paraguay, Venezuela and Brazil. Central banks bought a little over 534 tonnes of gold last year providing an important ballast to the price. However following on from recent movements in the gold price and subsequent downgrades on its outlook, we may see some central banks holding back on purchasing more, and as Draghi hinted, possibly selling. The following table shows how reserves for central banks stand as at December 2012.

    (click to enlarge)

    Historically Gold has acted as a fairly good inflation hedge and is included in many investment portfolios for this reason. However as we have seen with Japan, QE does not necessarily lead to inflation. The velocity of money is still very low as a majority of monetary easing is being used to purchase government debt, which is generally held by banking institutions, pension funds and insurance companies. As such, the money rarely filters down through the system. If this extra supply of money does not cause inflation, but rather lowers the prices of goods through weakening the currencies of developed nations it will actually bring with it heavy deflationary pressure. This is not a supportive environment for gold, and as we have recently seen CPI remains fairly subdued globally.

    (click to enlarge)

    The long term prospect for this commodity is becoming more unfavourable as many investors are aware the mass global monetary easing cannot go on forever. Since the onset of the credit crisis in 2008, we have seen almost $3tn of quantitative easing (QE) globally which has provided continuous support to Gold. However as the FED minutes again revealed, hawkish tones from a number of committee members give rise to doubts their 'unlimited' monetary easing will continue past this year. Furthermore, the recent announcement from Bank of Japan that they plan to do $75bn a month of QE had little impact on the gold price, giving the impression investors are becoming more skeptical about QE and its support for gold. Has this can been kicked down the road too much?

    Gold tends to react heavily to technical chart levels and as seen below it has broken through a fairly significant level at $1,530. Since doing so, in the space of a day, the price fell an extra 3% with spot gold closing at $1,483.

    (click to enlarge)

    After the weekend the market opened down another 5%, the day proceeded to spiral with spot gold hitting as low as $1,350, as institutional investors began selling. All the long term holders of gold may be saying it is so cheap now! But in relation to what? Gold has very little fair value, a small proportion is used in technology, a majority is in either jewelry or investment which pertains little real use. As such it is hard to quantify what a fair price is. With the environment for a high gold price diminishing, there could be very little in the way of gold falling all the way back to $200 and ETFs will facilitate it moving there that much quicker.

    Chart Sources: Wall Street Journal, The World Gold Council

    Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

    Stocks: GLD
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