Gold: A Risk Asset?

Includes: GLD, IAU, SGOL
by: QFinance

By Anthony Harrington

After tearing away to the 1900s in September 2011, and making goldbugs everywhere think that the $2000 mark was within reach, the tide turned for gold. In a breathtakingly short period of time the price wandered back down to the low 1500s and at one point the mid 1400s looked on the cards. Now it is back in the 1780s at the time of writing, and somewhat marooned there. However, the kind of sudden drop gold experienced through the end of 2011 tends to make people think of the 1980s, when gold crashed to sub $300 – precisely the point when former Chancellor Gordon Brown, in a splendid example of how not to time the markets, decided that the moment was ripe to sell off the UK’s gold reserves.

Brown’s venture into trading secured a price of around $260 an ounce for the nation, instead of today’s price of $1735, or thereabouts. Brown could have got almost seven times more if he had been better advised, but the man had the reverse Midas touch, so there was nothing to be done.

However, that was then, and this is now. Despite the suddenness of the onset of weaker pricing, gold has steadfastly refused to collapse in value. Since its low point of 1521 on 1 January 2012, gold has rallied more or less steadily to its present level of 1780-something. This is either whiplash volatility or range trading within a 50 to 80 point range, depending on your perspective. Either way, it is not yet even remotely looking like a major collapse in the price of gold is on the cards.

In a recent blog for Bullion Vault, Adrian Ash, who runs the research desk, points out that demand from China and India continues to be extremely strong. He cites the World Gold Council saying that Indian and Chinese households between them bought 1 in every 2 ounces of gold sold worldwide in 2011, with gold demand from China now running at 0.6% of the value of its GDP, while India currently has demand worth a massive 2.7% of the country’s GDP. Gold imports into China have tripled over the last five years, which has worried Beijing enough for it to impose a requirement on China’s gold importers to have every shipment agreed not just with the People’s Bank of China, but also with the State Administration of Foreign Exchange. This however, will only delay, rather than deter the flight of wealth into gold. For Chinese demand to really weaken, the authorities would have to ban shipments or make other forms of investment a lot more accessible to the ordinary citizen. Ash’s point is that continued extraordinary levels of demand tend to be self limiting both because of the consequent price increase, which ultimately deters investors and reverses the trend, or because the authorities in major gold buying countries get irritated and step in to stop gold imports from skewing their balance of payments figures.

Surprisingly, the price of gold has been highly correlated with risk assets for much of the last 12 months or so. Surprising, because gold is often seen as hedge against fear, and when markets tumble gold usually goes up – for a bit at least. Not this time round. When investors get really shaken up by the state of the global economy, they don’t turn to gold. They flee to the dollar as the deepest pool of liquidity on the planet. A higher dollar price means you get more gold for your dollar and the price of gold falls. So fear only stimulates the gold price when that fear is to some extent under control. Once anxiety hits the point where there is a scramble to the dollar, then gold loses its lustre and sheds value fast. Does this make it a good hedge? Personally, I doubt it, but there are an awful lot of wealth managers who take it for granted that every portfolio should have about 5% in gold as a hedge against inflation and against a meltdown in other asset classes. My point is that when this happens, the price of gold tends to tank along with the price of commodities generally – some hedge!