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ยป Looking past the near-term turmoil and weakness in the gold market
Date published: 15/11/2011
Looking past the near-term turmoil and weakness in the gold market
So apparently the gold bubble has burst, at least according to the media. The weakening value of gold over the fortnight in particular has led to a rash of negative comments with respect to the metal’s future.
One really has to take a step back and put a commodity’s price fall into its proper perspective.
Gold is 12% weaker (or $US226.90 in price terms) than it was a month ago but by the same token, the metal is still 25.7% higher (or $338.70) than 12 months ago, even accounting for the latest price correction.
As the price chart below clearly demonstrates, it’s hardly a matter of the gold bubble bursting.
Figure 1 Gold Price - Volume
The graphic demonstrates a steady climb in the price of gold (black line) for the past five years, although prices have surged over recent months.What we are seeing is a price correction that is indeed healthy for the market. And of course it’s clear there was a similar correction back in the latter part of 2008.
These types of corrections are normal and not unexpected. Since the start of the quarter, gold bullion rallied by more than 25% to its recent record high of $1920, on the back of investor nervousness. At $1600, gold merely reverted back to its trend-line.
The graphic also reflects one of the major anomalies of gold’s strong price run since late 2008 – that being the corresponding underperformance of gold equities.
The gold line above represents the Philadelphia Gold Index. What’s apparent is that during the immediate sell-off in the wake of the GFC, gold (like everything else) was hit hard but gold equities were hit even harder.
And gold equities have maintained their relative under-performance since late 2008 until now. In fact, the performance divergence is once again growing.
What this means is investors remain somewhat nervous about equities of all types since 2008.
While gold equities should naturally benefit from the strong underlying performance of gold, investors have remained nervous about share market exposure. Hence, they’ve opted for the relative safety of physical gold rather than investing in gold stocks.
The important thing investors have to understand about the recent gold price correction and the correction in late 2008 is gold has been sold off because it has been a profitable asset.
It has effectively been utilised as a source of funding for margin calls made on declining assets in investors’ portfolios, like equities.
This means gold is effectively undergoing forced selling.
Many inexperienced investors and market-watchers have an unrealistic expectation of how gold performs during a crisis.
Gold, like everything else, gets sold down during the midst of a crisis as desperate investors attempt to raise cash.
During the GFC, this amounted to a 25% price fall for gold, from which the metal strongly and rapidly recovered.
This time around it’s been a fall from a high of $1920 to a low of $1531 (a fall of 20%), on September 26, 2011 but the price has already rallied more than 8% (or $129 in price terms) from that low.
Again, you have to stand back and judge gold’s performance over a period that’s much more representative than merely just a few days.
When you do this, a la 2008, you get an appreciation gold does indeed retain and deserve its safe-haven status.
It’s also worth examining a long-term gold price chart that highlights the relative inactivity in the metal during the 20-year period between 1980 and 2000.
In fact, gold averaged $400 during this period.
It’s little wonder some investors have had trouble grappling with the concept of a rising gold price, given modern history taught them gold never moved much and was a poor investment performer.
Over the next few months it is likely the US dollar will retain its strength and the price of gold will under-perform for the time being, in a scenario similar to that post-GFC.
This provides a period of consolidation for gold and a buying opportunity for investors, before the next upward leg in gold’s price climb.
$1600, in my view is the critical gold buying level for investors.
Market disenchantment with the US Federal Reserve’s Operation Twist and the likely clambering in some quarters for some form of additional fiscal stimulus (potentially QE3) to help resuscitate the ailing US economy, are all factors likely to kick-start the next phase of gold bullion’s price ascent.
As a result, I’m maintaining my positive outlook on gold and gold equities.
For more information, or to discuss your specific situation, please contact me directly.
Gavin Wendt
Founding Director & Senior Resource Analyst
MineLife Pty Ltd
Now that you have read this, what do you think? Do you have other ideas? Please share you views with other members (eg by blog or discussion form) and/or request professional member(s) to contact you directly.
