First the good news; the gold price bounced on Thursday morning as the US$ weakened slightly. Now the bad – it still leaves the metal just off five-year lows and still smarting from its largest percentage sell off of 4% in the space of a minute early on Monday, July 20th when bullion to the value of $500 million was sold in a flash during Asian trading hours. Large sections of the market are piling on the pressure and forecasting/guessing/hoping that the price this year will fall below $1,000 an ounce at some point during 2015. (On Thursday evening in London, gold was trading at $1,093.5 an ounce).
A cursory examination of the macro-environment, not just in the US but globally, suggests that the gold price is indeed susceptible to a further sell-off. Inevitably the key is interest rates, and we know they will be higher this time next year. A morass of other indicators in the US such as employment, housing and consumer sentiment reinforce positioning away from this notionally defensive asset. While that might explain why the future gold price could be vulnerable to correction, it does little to help us understand why the prevailing sentiment has been so weak and for so long. The price hardly registered the drama regarding the possible ejection of Greece from the Eurozone, one of the most dramatic events in post WW2 European history. (The Euro is the world’s second most highly traded currency and there was a very real sense that this glue binding Europe together would have fragmented, if not faded away). Likewise cameras continue to remind us of the vicious conflicts in the Ukraine and across the Middle East. Both these stories have important economic and geopolitical considerations, but again they have not proved supportive of the gold price.
Another surprise? In the six years to mid-July 2015, China ‘only’ purchased another 604 tons of gold compared with 454 in the previous six year cycle. Its gold reserves are equivalent to 1.65% of its FX reserves, a decline from the previous period’s 1.85%. And this is a country anxious to reduce its asset base away from greenback. Perhaps the reasons for the continuing weakness are not that hard to understand. QE in the US did not lead to the collapse of the dollar, nor a revival in inflation. Meanwhile, the unwinding of positions in the largest gold exchange traded fund, SPDR, Gold continues to put pressure on the spot price of the metal.
Asset Performance in 2015
Yet just because something hasn’t happened doesn’t mean that it won’t…and this is a key reason why gold continues to have firm supporters. At the same time, this is a recipe for inaction, in that it presumes the motives for holding the metal will at some point be justified. Possible examples may include a resurgence of retail buying in China when consumer confidence improves, or global fears over inflation emerging (again). Yet the uniqueness of gold as an asset (crucially its absence of yield so how are you able to value it?) means that gold bulls are stuck when seeking alternatives. Unlike equities or bonds, there are no alternative to gold; if you are not ‘for it’ which presumably entails ownership, you are ‘against’ it. No other asset evokes such passion, but then none have its history.
Yet investments stand or fall by their performance. Analysis by Christophe Spaenjers, a professor of finance at HEC Paris Business School has shown that since 1975, the year when US citizens could own gold in any form and quantity they wanted, net returns on the metal after inflation have trailed its key alternatives. The scorecard was:
Annual Real Returns in the US Since 1975 (%)
Should you have gold in your portfolio and if so, proportionally how much should you have? Well, we can say with a high degree of confidence that the gold price will, at some point, start to climb again and breach $1,500 per ounce and overtake its previous (unadjusted for inflation) record of $1,921 an ounce in September 2011. But with equal, perhaps even more confidence we see the price of gold continuing to slip to $1,000 per ounce and here we stick our neck out a little bit more and see that occurring within the next 12 months. We cheerfully admit that none of the above has been carried out using any complex algorithms, studying the output of gold mines around the world, or analyzing the latest consumer demand levels from India or China. It’s just the sense we have of what is going to happen, and in the absence of a valuation model is one we feel is as valid and appropriate as any other.
As for how much gold should comprise of one’s total portfolio, analysis by Norges Bank Investment Management in Norway have calculated the total value of the world’s financial assets at the end of 2014 as $102.7 trillion. They compared that with the World Gold Council’s estimate of the value of gold held for investment worldwide at $1.4 trillion, and came up with a theoretical percentage allocation figure of gold in an investment portfolio of 1.3%. Extreme moderation is the watchword.