Gold and Precious Metals

Is downbeat gold a good investment?

Gold remains pretty unpopular these days. The price peaked in September 2011, fell hard during 2013 and has been in a bear market since then. That said, it’s held up well this year as commodities such as oil have collapsed. There’s a lot of negativity around about gold, and some evidence that the price could fall further. On the other hand it looks like it’s still highly valued as insurance against financial catastrophe in a debt sodden world.

As I write the gold price is US$1,166 per troy ounce. That’s down 38% from the heady heights of US$1,894 reached on 7th September 2011. There’s no doubt – at least when the price is measured in US dollars – that gold has been in a tough bear market these past four years.


Bull and bear: US$ gold price over past 10 years

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(Measured in other, weaker currencies the picture isn’t nearly so bleak. For example, for Brazilians, gold has been in a raging bull market when priced in their reals, the local currency.)

That said, gold has held up relatively well against the US dollar over the past year or so as commodity prices in general have collapsed. The Reuters Jefferies CRB index of commodities is down 29% in the past year. On the other hand, gold is down just 3%.

One of the big changes in the gold market over the past decade or so has been the introduction of gold exchange traded funds (ETFs). These sell gold-backed shares to investors, making it easy for them to invest in gold via a brokerage account.

Before ETFs small investors’ main option for buying and selling gold was via physical bullion coins, such as South African krugerrands or American eagles.

ETFs also make it easier for investors to trade gold on a short term basis – jumping in and out on a whim. Before ETFs small investors’ main option for buying and selling gold was via physical bullion coins, such as South African krugerrands or American eagles. But those have a big price spread between sale and purchase prices, which means they are best as long term stores of wealth – not something to trade frequently.

The first and by far the biggest of the gold ETFs is the SPDR Gold Shares (NYSE:GLD). Like all the gold ETFs it experienced big selling pressure as the gold price fell. At its peak in late 2012 and early 2013 GLD controlled over 43 million ounces of gold. As of today that has fallen by nearly half, to 22 million ounces.

Most of that huge outflow happened during 2013. That selling pressure – as well as selling from other sources – put huge downwards pressure on the gold price.

But outflows over the past year have slowed considerably. GLD has shrunk its ounces by 6.7% over that time. In fact the amount has even been on a slight rising trend in recent months.

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So things appear to have stabilised, at least as far as the ETFs go. Another source of pressure on gold over the past couple of years has been a big crackdown on corruption in China under President Xi Jinping, the country that buys the largest amount of physical gold.

This has meant fewer exchanges of high value gifts between party members, such as gold jewellery. That lack of physical demand has added to pressure on the gold price. (I read a while ago that around 250,000 officials were under investigation for corruption in China. The figure is probably even bigger by now.)

All in all sentiment in gold markets has been pretty weak. Last week saw the London Bullion Market Association hold its annual precious metals conference in Vienna.

This is a gathering of all those involved in the gold business – miners, traders, investors, processors. The latest conference attracted 690 delegates from around the world. That was fewer than in recent years – another indicator of poor sentiment.

Clearly the conference took a downbeat view of the gold price. Delegates had predictions for an average gold price in 12 months of $1,216/oz when they arrived. When they left, after listening to the talks and chewing over the fat with other attendees, that had fallen 5% to $1,160/oz. But perhaps that was down to their hangovers, brought on by Vienna’s late night bars.

One of the attendees – indeed one of the presenters – was Charlie Morris, who I’ve known for years. He has had an active interest in gold markets for a long time, previously investing in large gold positions as a fund manager. These days he writes a lot about gold in a free monthly report called Atlas Pulse. It’s a bit technical at times, but always contains interesting insights into gold (and other things).

Charlie thinks gold remains firmly in a bear market. It may not fall hard, but there is no clear bullish trend as yet. In particular he has a number of models that attempt to put a fair value on gold, meaning the price that gold “should” trade at.

I won’t go into all the details here. But he values gold in three ways: using bond market data, versus commodities and versus consumer prices. All of the models take a long term view.

Taking the mid-point of that at $850 the implication is that gold could fall around $300 per ounce from the current price.


Overall they indicate that the gold price should be somewhere in the $700 to $1,000 range per troy ounce. Taking the mid-point of that at $850 the implication is that gold could fall around $300 per ounce from the current price.

But, as Charlie correctly points out, this doesn’t mean that the gold price will actually fall to that level. The data suggests that there has been a big insurance premium baked into gold ever since 2008, when the global financial crisis really got going.

It seems that the difference between his models and the market price is more or less made up by that insurance premium. There’s still plenty of fear about.

As Jim Grant, a well known commentator on markets with decades of experience, recently put it: “Gold is something to hold as an investment in the disorder of money, as manipulated and managed by the central bankers.”

In other words, even though the price of gold has fallen in recent years, it’s still worth having some as insurance against calamity. The world continues to pile on debt, financial derivatives markets are still huge and overly complex, governments are still going bankrupt, interest rates are still pinned to the floor, and money printing by central banks is still rife.

Given that market sentiment is so poor towards gold as well, this means investors should continue to accumulate it. By doing that they are taking a contrarian position against the majority bearish position, and still expecting there to be further financial crises in future.

Ultimately, gold’s fortunes will be determined in the physical markets, where buying is dominated by the fast growing emerging markets such as China and India.

There will always be short term swings of sentiment in financial markets, and gold is no exception. But in the long run it will do just fine.

Stay tuned OfWealthers,

Rob Marstrand

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Rob is the founder of OfWealth, a service that aims to explain to private investors, in simple terms, how to maximise their investment success in world markets. Before that he spent 15 years working for investment bank UBS, the world’s largest wealth manager and stock trader with headquarters in Switzerland. During that time he was based in London, Zurich and Hong Kong and worked in many countries, especially throughout Asia. After that he was Chief Investment Strategist for the Bonner & Partners Family Office for four years, a project set up by Agora founder Bill Bonner that focuses on successful inter-generational wealth transfer and long term investment. Rob has lived in Buenos Aires, Argentina for the past eight years, which is the perfect place to learn about financial crises.