Is gold losing its shine?

18th May 2012

Today's Telegraph outlined the problem: "Futures contracts for the precious metal were on Wednesday trading 21pc down from their high last summer. That signalled gold for June delivery was into the territory seen as a "bear" market – when an asset plunges 20pc or more."

The piece attributes this slide in the price to the escalation of the eurozone debt crisis, which is causing investors to liquidate their gold holdings. This may be indirectly true, but there is more evidence that the real reason is an increasing preference for the dollar: "Instead of gold, investors are turning to the dollar as they shun the eurozone and its shared currency. The US dollar index, which tracks the greenback's strength against six rivals, climbed a 13th day to reach a four-month high," the article says later.

This view is supported by recent flows: The dollar strengthened in response to the elections in France and Greece.

But structural demand for gold appears to be in tact. Japanese pension funds are switching into gold: "Okayama Metal & Machinery has become the first Japanese pension fund to make public purchases of gold, in a sign of dwindling faith in paper currencies." While demand from China continues to increase: "Gold demand in China may surge as much as 30 percent this year as rising incomes boost consumption."

This supports the theory that it is investors seeking an alternative ‘safe haven' driving the price. So why are investors preferring the dollar? For a start, it appears to be cheap. Cazenove head of multi-manager Marcus Brookes says in this Citywire piece: "The dollar looks so cheap to us and it has been beaten up for so long. We believe that fundamentally it should be strong because the US has far superior growth and its companies have superior returns on capital.

"We don't think the US's time is over yet. It still has the biggest savings market in the world and used to outsource everything to China but because of the high cost of oil many manufacturers are moving back to the US."

The dollar is also supported by the recent strength in the US economy. While its growth rate of 2-2.5% does not look strong by historic standards, it is on a better growth trajectory than other developed markets.

Gold, on the other hand, had begun to look extremely expensive. Although there were a number of structural supports for price of gold such as increased buying from central banks, everyone had been a gold bull for some time.

However, some are still banging the drum for gold. http://goldnews.bullionvault.com/gold-futures-051420122: "Gold has moved lower and is trading at levels not seen since December 2011, but we do not think the gold bull market is over," says a note from Morgan Stanley analysts.

Looking at the charts, "Technical damage has certainly been done [but] we do not think it is irreversible," they add, pointing to a sharp rise in speculative "short selling" by Gold Futures traders now expecting prices to fall further." Not everyone is backing the greenback yet.

 

More on Mindful Money:

Gold: A risk asset?

Gold – Will the bulls come back?

End of QE will damage gold prices

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The Financialist

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