Are the best days for gold over?

The Straits Times
Goh Eng Yeow
1/7/2013

HOW times change: At the start of the year, the bet was whether gold or platinum would hit the unheard level of US$2,000 an ounce first. Now it is a race to the bottom.

Both are fast heading to US$1,000 and all the talk is of worse to come even if that support benchmark is breached.

Depending on which wire report you read, gold is suffering its biggest rout in percentage terms since 1971 or it could be 1920, after plunging 7.1 per cent to a three-year low of US$1,202.50 last week.

Swiss bank UBS - one of the biggest gold bulls - has slashed its forecast from US$1,750 to US$1,050 while Credit Suisse set a target of US$1,150.

Holding gold had been a good bet over the past four years, as the United States Federal Reserve and other major central banks depressed interest rates effectively to zero to try to restore the global economy to health.

But those bets are off after the Fed flagged its plan to "taper" off its massive US$85 billion (S$108 billion) monthly bond-buying programme.

That sent long-term bond prices plummeting and caused bond yields to go up, and thus more attractive as a place to park your cash.

Gold, on the other hand, has become a lot more painful to hold, as it offers no returns other than a possible appreciation in price.

It is the speed at which gold had plunged in price that raises more concern.

Prices have crashed an eye-popping 35 per cent since hitting a high of US$1,798 an ounce last October.

The sell-off exacerbates concerns that the US Fed may be pushing the global economy into a deflationary slump where falling prices dampen consumers' appetite to spend.

Such alarmist talk may be premature. After all, the gold price is determined by a complex web of economic factors - market sentiment and supply and demand - so it is vulnerable to the same sudden price swings as equities and bonds.

The World Gold Council, for example, noted in a report in May that the fall in investment demand for gold had masked a growing appetite by retail investors for gold bars and coins.

It may have a point. Demand for gold comes in various guises - Indian farmers buying it after a good harvest, central banks diversifying their reserves, and financial traders using it as a currency hedge.

The price roller-coaster has been exaggerated by the huge increase in gold trading via a new type of financial instrument known as exchange-traded funds (ETFs).

These offer investors a low- cost way to buy into the precious metal, as they are traded like shares on a stock exchange.

Gold ETFs have attracted huge inflows from traders and big-time hedge fund managers, such as billionaire John Paulson and other speculators taking bets on price movements.

As ETFs are traded on major stock exchanges, their positions can be quickly unwound if prices do not move as expected.

That has turned out to be gold's Achilles' heel. Any unwinding of gold ETF positions can trigger computerised selling, which further exacerbates the selling pressure.

Since the start of this year, the SPDR Gold shares - the world's largest gold ETF - has experienced a precipitous 28.2 per cent plunge in its precious hoard to 969.5 tonnes, almost mirroring the drop in the gold price in percentage terms.

By some estimates, there is still about 288 tonnes in ETF positions acquired above US$1,300 levels, and this may further fuel selling pressure if their owners decide to crystallise their losses.

It leads strategists, such as UBS Wealth Management's head of commodity research Dominic Schnider, to warn that the tepid investment demand for gold may last longer than anticipated.

Amid all these uncertainties, it is not surprising to find that even retail buyers are holding back on gold purchases, unlike in April when a plunge in price lured them to snap up bullion in a big way.

So where will this leave gold once the dust settles on the ETF sell-off?

Those with long memories will recall that a similarly long rally in gold during the 1970s, which enabled it to hit a then all-time high of US$850 in February 1980, was followed by a decade-long slump that saw prices crash to US$250 by 1990.

Sure, gold is seen as the ultimate "safe haven" asset, but that is scant consolation for gold bugs nursing recent losses.

As for platinum, that other once shiny sure thing has fallen 23.6 per cent to US$1,323.85 an ounce since February.

All that glitters is not gold. It is not platinum either.

engyeow@sph.com.sg