After record gains of more than $1900/ounce in September 2011, the price of gold had many months of consolidation with some temporary sell-offs that dropped to just above $1500 a few of times. This occurred when there were high tensions in other markets often because of European news. Because price of gold rose rapidly during the last decade and has recently lost strength, many investors are wondering if the gold investment bubble could burst.
The chart above shows the price of gold consolidation in the last 10 months, with some sell-off when tensions increased in Europe. Why did it happen and gold didn't act as a safe haven? I believe that there're many causes, but the most important are:
- Margin calls and need for dollars: when the markets fall heavily and volatility increases overall, exchanges usually tend to raise margins and some investors could have been forced to sell gold to find cash to cover other asset losses. Moreover often gold fell when gold leases became more negative, a signal that gold was lent to receive dollars and meet some obligations.
- Weak fundamentals in 2012: according to World Gold Council (WGC)'s data, demand from technology and jewelry was weak in the first quarter of 2012 (it fell on annual basis, Table 1 WGC Global Demand Trends 1Q). The only kind of demand which showed increase was the investment one, especially ETFs because demand for bars and coins also fell. At the same time, supply showed an increase. The low level of demand could be explained by the weakness of global growth and India's problems. India is the former first consumer in the world of gold (China overcame the country in the last 3 quarters). India's demand dropped because of the strong depreciation of Rupee that made gold very expensive for locals and because government placed new import taxes on gold and jewels (partially removed after a month of strike from jewelries). WGC had not published the 2nd quarter data yet, but India's demand should have been very weak according to the words from Bombay Bullion Association. Instead demand was strong in China in the 1st quarter and likely in the 2nd as well.
- Speculators reduced the net long positions on gold over the last months. Net positions are close to a 4 year-low according the CFTC.
- US dollar appreciation versus the euro. Typically gold tends to move in the same direction of the cross, even if sometime there's a divergence.
- Overcrowding and excessive attention from the financial press. The record price increased the attention of TV and Financial press on gold; most talks were optimistic about a future rise of the price. Street people talked about buying it. Excessive optimism about an asset is usually not good for short term returns.
This was the recent past, but what about the future?
I tell you that I am a bullish-biased guy on gold for the next 1-2 year and this is why:
- Increasing level of interest from emerging markets central banks and investors to diversify their reserve and savings away from the US dollar. Emerging markets countries have plenty of currency reserves but not much gold compared to western countries. The fear about a future depreciation of dollar is driving them to buy gold (so far this year, big buyers were Russia, Mexico, Kazakhstan and other countries). China imported a high amount of gold from Hong Kong.
- High probability that the crisis will still last for a few more years. Europe is not expected to solve its problem soon, the US could have a difficult year in 2013 when they'll try to reduce their deficit; other risks could be the China housing bubble, a Japan debt crisis, a Middle East war with Iran and others.
- Central banks will likely continue to inject a huge amount of liquidity worldwide to avoid banks/states collapse, that's good for gold! The Federal Reserve could inject new liquidity starting in August because US macro data deteriorated recently.
- Negative real interest scenario now in most developed countries because of a low level of nominal interest rates. Negative real rate was historically good for gold performance.
- More use of gold as collateral in the futures exchanges (example CME); possible use of gold in banking capital adequacy ratios.
- Long term view of US dollar depreciation because of the worsening of public figures, especially vs. EM currencies.
- The real price record (adjusted for inflation) is still much higher than the nominal price. It's around $2200-2500 depending by the variable you use for inflation.
- Low level of net long speculators positions: at the moment speculators are not positioned for a rise of gold therefore there's space for many of them jumping in again if gold technically breaks the triangle or further QEs will materialize.
Why you shouldn't buy gold or should you sell your holdings?
Basically you can avoid gold if you believe a global recession is not coming, Europe will fix all problems this year and central banks could be forced to raise rates heavily starting from 2013 because a new world economic boom is just around the corner.
In the short term you should not buy if you believe Bernanke will never announce a QE3 and Congress will stop him. In Summary, you shouldn't buy gold if you think that world is going toward a new economic boom and rates are going to rise in the near future
If this is not your view, gold should have a place in your portfolio. The optimal would be to hold the physical one if you have a safe place to store it. If you can't hold the physical, you can buy physical ETF ((NYSEARCA:GLD) for example) even if it could not protect you if the situation will become much worse than now.
Technical view: the 10 weeks exponential moving average (10w EMA) crossed below the 40w EMA in May and there is not a signal of an imminent cross above. Last time this signal happened was in 2008 signaling an high volatility period ahead. If you aren't invested yet (or if you're planning to add more gold), I'd wait for a technical buy signal before buying more because there're risk in the short term. The weekly dynamic resistance is at $1700/ounce, while the static resistance is at $1640. Most aggressive investors could buy above it; more prudent ones, above $1700. A break below $1500 would suggest an hedge (using put options on GLD) for the short term.
SUMMARY - The fundamentals point to another increase of gold in the next 1-2 years if global financial system stress continues. Moving averages signal a "wait and see" approach with some key levels ($1640 and $1700) to be monitored for new/further entry points.
From a portfolio view, think about gold as an insurance. It could weight up to 10% of a portfolio, not more because it's better to not go "all in". I am not a pure gold bug but believe that there are many motives to have it in a portfolio as diversification.
In the short term, record in your agenda these 2 days: 17-18th July. Bernanke, the Fed's governor, will attend a speech in front of Congress and, if he thinks that the 1st August is the right FOMC meeting for a new QE round, he will prepare the market. If he signals it, jump on gold above $1640 or $1700 (according your investing style). If instead it doesn't signal, I'd be cautious because the recent support could be tested again and gold could drop below $1500.
Whatever your attitude is, gold (especially the physical one ) should be in every portfolio with a percentage varying according to your risk profile (conservative is up to 5-10%).
Disclosure: I am long GLD.