Is Gold The New Lead?

There has been a lot of negative buzz around gold ever since it entered a downward trend late in 2012. In April, gold exchange traded funds [ETFs] were being sold off at a record pace and gold prices dropped to 2-year lows. When the 2012 low of $1,500 was breached, prices dropped to almost $1,300 per ounce. 143 tons worth of gold were sold in SPDR Gold Shares (GLD), the world’s highest valued gold ETF during April. This is the most severe drop for the gold-backed fund ever since its inception in 2004.

Much of the selling was initiated by financial institutions and hedge funds, which represent roughly 50% of GLD’s holders. An April 26 report from Deutsche Bank AG expects these types of investors to cut future gold holdings by half.

Over 2 days, prices spiraled out of control as margin calls began ringing even for bullish individual investors. Stop-loss orders were also triggered overnight. As the commodity fell roughly 10% in a month, many were quick to recognize the beginning of a multi-year bear cycle. The substantial drop from gold’s peak of $1,923 further supports this.

Another gold-related ETF, Vectors Gold Miners ETF, (NYSE:GDX) also suffered substantial losses this year. The ETF, which invests primarily in gold mining stocks lost 40% in the last 6 months.

The Beginning of the End

Gold ETFs and bullion prices have been going nowhere since October 2012. Analysts were recommending investing in more attractive asset classes such as stocks for months prior to the April crash. A recommendation by Goldman Sachs to short gold a few days prior was another major catalyst of the mid-April dip.

Mounting worries about the European economy also worsened with news about Cyprus possibly forced to sell off its gold assets. Many felt this was an indicator that other struggling Eurozone central banks may follow suit.

The Fed then had also just announced that it was ready to cut back stimulus injections into the economy whenever necessary. Low inflation rates have been worrying the Fed while it continues to pump cash into the economy.

Lackluster economic data from China in the same period also had the entire market taking a hit.

As the most popular precious metal, gold is very sensitive to these global macroeconomic issues. Negative pressure was building up for months until a combination of factors from different sectors finally triggered the collapse.

Other precious metals like silver, platinum and palladium did show similar patterns in the same month.

The Aftermath and the True Value of Gold

Weeks after the crash, gold ETF prices have recovered above the $1,400 level. Year-to-date, it is still down 13%.

While gold ETFs try to recapture their lost value, physical gold in the form of bars, coins and jewelry flourished. U.S. Mint data showed American Eagle gold coins increased 10-fold compared to April 2012. The first 4 months of 2013 saw U.S. gold coin sales increase to 502,000 ounces compared to 116,200 in the previous year.

In other parts of the world, the U.K. mint saw demand triple and the Perth mint saw orders reach 5-year highs.

India, the largest importer of gold, saw a 5-fold increase in demand over 10 days after the ETFs collapse. The Shanghai Gold Exchange saw trading volume reach record highs as well. In China, the second largest buyer for gold, people were lining up to buy gold as shops were running out of supply.

Despite the widespread panic and selling for gold-exchange products, traditional buyers of physical gold provided the real world support it needed.

Government central banks and individuals from different cultures will continue to use gold as a stable store of wealth. What we have seen in the last month and various other periods prior, is the volatility of gold exchange traded products. Unlike real gold which has held value over its entire history, gold ETFs are still new and much more susceptible to market pressures.

Gold ETFs can be mistakenly thought of as a direct substitute for investing in real gold. Gold, however, is a tangible asset. ETFs, on the other hand, are merely financial assets which have risks attached just like any other stock. The value of gold ETFs can easily drop when large market forces and trading volumes are involved.

If one’s goal is to create a hedge against long-term inflation, gold ETFs are in no way equivalent to owning the physical metal.

Where are Gold ETFs Headed?

The best way to go with gold ETFs at the moment as a financial investment is to follow the market. As much as these are susceptible to large cash outflows, it is indicative that other better yielding investments are available in the short-to-medium term.

The gold industry will begin to suffer if the price of gold contracts drop to below $1,200 an ounce. At this price, gold miners would struggle to meet breakeven levels exacerbated by increasing operational costs.

In the next 2 to 3 years, gold will most likely hover near current support levels. Current demand for physical bullion is still strong and uncertain economic periods will fuel continued gold buying. Dropping below the $1,200 or even sub-$1,000 mark is highly unlikely.

The recent correction though record breaking is not new for gold ETFs and bullion prices. In 2008, prices dropped from over $1,000 to $675; since then has almost tripled in price.

The negative hype around gold and its true worth as an investment is largely exaggerated. What happened in April 2013 was the result of large market forces pre-empting an eventual correction. Chart analysis also did not play well to its favor, making the effects even more pronounced.

With central banks actively managing inflation in the midst of a recovering global economy, interest rates will most likely remain stable if not drop. Large institutional investors will continue to invest in more actively growing asset classes. Meanwhile, traditional investors with longer-term views will provide the cushion gold prices need to remain stable and probably keep the entire industry sustainable.


About abwehra group

The Art&Science of Trading Gold
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