As I write this in late December 2009, gold sits at “only”! $1104/oz., when just about two weeks ago it was at its all-time secular high north of $1200. Many correctly called what seemed to be, at least in the short-term, a “gold bubble.”
But I don’t think it’s wise to write gold off completely. Gold is still at decade-long highs (up 270% over the decade compared to measly returns on the major U.S. equity indexes). And just two months ago, $1100 still seemed really bullish on gold – it was enough for Barrick to finally remove its gold hedges.
Importantly, the fundamentals that led to gold’s parabolic rise haven’t really changed. What happened, no doubt, was a lot of risk-management profit taking.
The Case Against Gold
There are a number of reasons, in theory, why gold should not be a good investment. It has a limited number of uses; it seems unlikely it could be a viable currency (so the dominant argument goes, despite the cases of gold being used as a currency increasing); and it attracts a lot of “hot” money or pure speculation plays which make it extremely volatile and unpredictable. Also, bullion doesn’t pay dividends.
This means that the SPDRs Gold Trust ETF (GLD) and similar bullion ETFs also don’t pay returns. You pay commissions instead, which cut into any rise in the gold price.
Gold stocks pay dividends, but there are unique problems with gold stocks, too. Bill Harris of Avenue Investment Management has pointed out that the price of bullion itself needs to be on an uptrend in order for gold stocks to do well at all (even if they’re turning nice profits with a flat gold price). If the gold price even so much as lingers sideways for a while, gold stocks turn soft.
Why Gold May Outperform Anyway
There are also a number of tried and true technical and fundamental reasons why gold is expected to continue to go up. First, it will go up inherently as part of a larger bull market in commodities that is expected to continue worldwide with the rise of emerging markets.
Second, the recent crash in the gold “bubble” is due more to short-term technical reasons than long-term fundamentals. It was probably overdue for a pullback, since in late 2009 it became a very crowded trade and its charts went up parabolically (never a good technical sign). And insofar as gold was largely a U.S. dollar trade (i.e., bought due to the fundamentals of a diluted U.S. dollar), it may have seen the correction due to the bounce in the USD. If the USD is still in a long-term decline, which many still think it is, then the price of gold will continue to reflect that.
A third factor beyond the simple USD-gold relationship, but which adds to it, is the USD’s status as world reserve currency. As more central banks diversify out of the USD, they buy gold (in addition to other currencies). This happened recently with Russia and China stating they had made more purchases of Canadian dollars, and with India’s infamous purchase from the IMF of 200 tonnes of gold bullion (it caused the gold price to shoot up over $20 in one day).
John Zechner of J. Zechner Associates (Canada) still thinks we will see gold between $1200-$1500 no problem once a consolidation phase has been completed in the short-term. In fact, there are many anti-gold-bugs, but there are less analysts among them who also think that gold won’t climb higher. Zechner points out that gold stocks in particular could be a good opportunity right now because their prices aren’t yet reflecting gold at $1100/oz.
I have to agree with Zechner. We’ve recently had some positive pronouncements about the recovery taking hold in the U.S., but third quarter GDP numbers keep being revised downwards, and the price of gold has found some support around $1100 again. Even if the economy in the U.S. recovers dramatically over the next quarter, the problems with the US dollar are still there and will be hard to reverse for some time.
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