Many investors, along with the man on the street, believe that gold, as a “real asset”, will retain its value in a high inflationary environment, but Nossek (pictured) says that there is no historical reason to think this.
“In the past we have never had QE to this extent and the history of gold as a hedge against inflation is predominantly based on what happened in the ‘70s and ‘80s, when there were two huge price shocks instigated by oil supply contractions,” he said. “The first was the OPEC embargo in the ‘70s and then the 1980 Iranian revolution. Those created huge rallies in gold because higher prices in oil filtered down into CPI.”
“That was at a time when we had just moved off the gold standard, central bank policy was entering a new direction and currencies were floating rather than fixed as they had been.”
“Since then we really haven’t had huge inflationary periods, although we had some mild inflation in the 1990s.”
Data from FE Analytics shows that gold has fallen significantly in recent months, having lost 11.67 per cent of its value since the start of the year.
Over three years the metal is still up 11.62 per cent, but is 22.21 per cent down since its high in September 2011.
Performance of gold over 3yrs
Source: FE Analytics
Nossek says that it could still have a long way to go.
“If you think about the price from a historical perspective, the directional downturn probably has much further to go if history is any guide,” he warned.
“When gold hit its peak on 14 January 1980 it was around $800. That price slumped by 70 per cent in real terms in just two years, so a price correction of 70 per cent in two years.”
“The recent peak on 5 September 2011 was $1,900 and we are now at $1,300 – $1,400; in inflation-adjusted terms we are down around 30 per cent, so there’s the potential for a prolonged slump in this price.”
Nossek warns that although there was a brief recovery from the metal’s sharp fall in April, when it lost 14 per cent in a week, the recovery was weak and looks to be over.
“Demand from sectors that have been key to supporting gold prices over the last couple of years are showing signs of petering out. For instance, physical buying this year has been mainly retail-driven and enticed bargain hunters to bid up from the battered price level in April.”
“The rebound was half-hearted and lost most of its gains since May.”
“Undermining the momentum of the recovery are professional and institutional investors who have been selling out of gold funds.”
“Institutional outflows have overwhelmed otherwise buoyant consumer demand for gold coins, bars and jewellery.”
The analyst says that the ongoing QE programs being employed are actually negative for gold, as they reduce the uncertainty in the markets that drive the gold price.
He says investors should be more worried about deflation, which could paradoxically be good for gold by increasing concerns about the economy and causing investors to hide in gold.
“The real risk is disinflation [lowering inflation],” he said. “CPI numbers are coming off benchmark. The target is around 2 per cent in the US but it’s undershooting those targets.”
“So the risk is deflation, and it is deflation that could instigate a rally in gold.”
Deflation refers to a period where prices fall and consumers delay their spending, causing prices to fall further and economic activity to reduce.
Nossek says that the danger is particularly high in the Eurozone, which needs a dose of the QE policy pursued here and in the US.
“There’s disinflation because huge unemployment creates uncertainty, and that’s spreading across European core and it means further out you may even get GDP contraction,” he said.
“There’s a huge fallout in domestic demand and exports are being used to replace domestic demand, but now that’s spreading to the core.”
“Companies are holding back spending and if they are spending it’s outside the Eurozone.”
Nossek points out that car sales are falling even in Germany, which is a worrying sign for the European internal economy.
The analyst says that the current level of unemployment in the Eurozone is intolerable, and the authorities are likely to have to change course eventually.
“My argument is we still need to have QE, especially in Europe,” he said.
“We need inflation to drive down debt. You can argue for ever about undermining borrowers, but it’s helping savers. This is all true, but the bigger picture is the real economy is not resolving.”
Some well-respected professional investors still think gold has a protective role to play in a portfolio, however.
The managers on the Ruffer Investment Company recently told investors that they were keeping a hold of their holding in the metal. They retain 5.7 per cent of their investment trust in gold bullion.
The trust is known for being cautious and having low volatility, and has managed to make 93.34 per cent over the past five years in troubled markets, according to data from FE Analytics.
Performance of trust versus sector over 5yrs
Source: FE Analytics
The managers say that it is hard to unpick the reasons for gold falling out of favour, and recognize that its recent weakness is a blow for the idea it can hedge against inflation.
However, they claim that as protection against the tail-risk of countries defaulting it still retains its appeal.