Gold Collapse: The Start of Something Big?

April 23, 2013 at 07:55


In August 2011, a Gallup poll asked Americans what they thought would be the best long-term investment: 34 per cent said gold, 17 per cent said shares.

It’s too early to declare a winner, but the early results are in. The exchange traded fund that tracks gold – the SPDR Gold ETF – is down 17 per cent since the survey was taken. The S&P 500 is up 38 per cent.

Gold has lost nearly one-fifth of its value this year alone, including more than 10 per cent in less than a week, last week – the worst decline since the early 1980s, when the yellow metal began a two-decade slump. Whether the current slide is the end of gold’s bull run, or just a short-term drop, no one knows. What is clear is that gold isn’t the wealth-preserver many thought it was. Some gold stocks, like Silver Lake Resources (ASX: SLR) and Kingsgate Consolidated (ASX: KCN), have lost more than half their value in the last year.

The irony is that the goldbugs may get the story right but the investment wrong. Like any asset, gold is forward-looking and prone to wild overreactions. So prices doesn’t always mesh with what’s going on in the economy.

Inflation in the 1980s averaged nearly 6 pe cent – triple current levels – and gold lost more than half its nominal value. It is entirely possible that the coming years will bring high inflation, but tumbling gold prices. Just as the internet blossomed while the Nasdaq plunged from its high in 2000, asset prices can gallop far away from the stories people buy into them for. Indeed, they usually do.

Historically, gold has surprisingly little correlation with inflation. As one Citigroup research report put it: “There is no obvious relationship between the gold price and inflation.” Instead, gold correlates fairly well with two events: negative real interest rates and financial panic.

But if the economy is healing, as many think it is, real interest rates are likely to rise. And as the Cyprus bailout showed last month, markets appear to be well past the panic stages of the financial crisis. One interpretation is gold’s fall is the shift in how investors perceive risk – away from a world obsessed with panic and collapse towards one focused on long-term growth.
For those in gold for the long haul, that should be unsettling. Over time, gold’s real return averages close to zero. Deutsche Bank’s Long-Term Asset Return Study compared the average annual real returns, between 1838 and 2012, of various asset classes.

The results were clear. Stocks gained an average of 6.49 per cent, US Treasury bonds 2.77 per cent and gold only 0.46 per cent.

The share market falling 20 per cent or more is typically nothing for long-term investors to fret about – historically, it’s a once-every-five-years occurrence, with large gains over time. Gold is different. Over the long haul, the best it will do is preserve wealth. In between, it goes through periods, sometimes decades-long, of boom and bust.

No one knows if the gold story has peaked. What we know is that it’s riskier than many believed.