Here’s why cloud over gold has silver lining

December 2, 2013 at 09:04


Investors in gold will not forget 2013. With the price of the precious metal falling by more than a quarter this year, a bull run for bullion which stretched back more than a decade came to a crashing end.

This year’s price fall was foreshadowed by a string of negative comments from analysts.

In February, Credit Suisse said the market had already peaked while in April Societe Generale warned that the “end of the gold era” was nigh and Goldman Sachs recommended that investors sell gold futures.

Those warnings were followed by a fierce attack in mid-April by short-sellers in New York which resulted in gold’s sharpest two-day price tumble since 1983.

Further price volatility erupted in June after the Federal Reserve for the first time outlined a framework for scaling down its programme to support the US bond market.

Asset managers and wealthy individuals reacted by selling their holdings, leading to large outflows from gold exchange traded funds.

Investors in these vehicles – whose expansion after the financial crisis won them the label of “the people’s central bank” – had won a reputation for being “sticky” and reluctant to sell even during periods in which the gold price fell.

But that reputation was shattered this year.

Holdings in gold ETFs have now sunk below the 2,000 tonne mark, down 27.7 per cent after ending 2012 at a record 2,767 tonnes, according to Barclays Capital.

Suki Cooper, precious metals analyst at Barclays, says the threat of further ETF outflows is a clear risk for the gold market.

However, if the gold price can hold above the USD 1,200 mark, then fewer ETF holdings will be lossmaking, which could help to stabilise the amount of metal in these vehicles, says Ms Cooper.

But she also cautions that factors such as uncertainty about US monetary policy that previously supported gold have failed to reignite investor demand in recent months.

James Steel, precious metals analyst at HSBC, says gold’s weakness this year cannot be blamed solely on concerns about future changes in US monetary policy.

With the global economy entering a more “normal” recovery phase, Mr Steel says this has reduced demand for gold as a haven against unexpected crises.

Mr Steel says he expects to see a modest recovery in ETF holdings in 2014, adding that investment flows are now less of an influence on the gold price than physical demand for jewellery, coins and bars.

HSBC is forecasting that sales of coins, medals and small bars could increase by more than a third to a record 1,700 tonnes in 2013 as this year’s fall in prices has attracted more interest from retail investors. HSBC is also forecasting that global demand for gold jewellery will increase 16 per cent this year to around 2,200 tonnes, helped by the growing appetite of consumers in China, which has overtaken India as the world’s largest jewellery market.

“Essentially, physical gold stocks are migrating from western investment hands to eastern consumers,” says Mr Steel. Evy Hambro, chief investment officer of BlackRock’s natural resources equity team, says that buying interest in small gold bars has more than offset selling by gold ETF investors this year but this has not been felt in the price. Mr Hambro says selling pressure from gold ETFs is likely to moderate as most of the holdings acquired after the US central bank started quantitative easing have now been liquidated.

Looking forward, Mr Hambro says investors are underestimating the strength of future demand growth in China where imports this year have been significantly higher than expected. “If China starts to move towards similar per-capita gold consumption levels as India, that will be very supportive for the market”, said Mr Hambro.

Joni Teves, precious metals analyst at UBS, says demand from China should remain resilient but is unlikely to match further selling from ETF investors and hedge funds. UBS has cut its three-month price forecast to USD 1,100 an ounce. Nicholas Brooks, precious metals analyst at ETF Securities, says gold still has a worthwhile role to play for long-term investors both as a portfolio diversifier and as a hedge against extreme situations.

”The extent of monetary easing in the developed world makes it likely that we will see inflation rising or currency debasement or another severe financial crisis,” says Mr Brooks. Acknowledging that 2014 could be a tough year for tactical gold investors if US interest start to rise and the dollar strengthens, Mr Brooks insists that gold still provides important portfolio protection for long-term investors worried about political risks and market crises that might erupt over the next ten years.

“The best time to buy an asset is when it is out of favour, as gold is now. Gold is now relatively cheap as an insurance for long-term investors,” says Mr Brooks.