Investors should beware a “perfect storm” brewing in the market for gold and gold mining equities, analysts and economists warn.
Anyone with a nugget of exposure to the gold price has seen the value of their holding plummet over the past three years.
Whether you are holding gold directly, indirectly through an exchange traded fund (ETF), own a fund of gold mining equities or the underlying stocks themselves, the chances are you have lost a huge slug of your original stake.
According to FE Analytics, while there have been a few occasion where the price has made some recovery since October 2012, the likes of CF Ruffer Gold, Investec Global Gold and BlackRock Gold & General have lost up to two-thirds of their value since then. The Bloomberg Gold Sub index is down 37.55 per cent over the same period.
Performance of indices in 2014
Source: FE Analytics
In recent weeks this trend has only accelerated with the gold price and gold mining equites seeing some of their rapidest falls. The gold price now sits below $1,100 per troy ounce for the first time since 2009.
Colin Cieszynski, chief market strategist at CMC Markets, is predicting a “perfect storm” for further weakness in the gold price due to a number of factors.
He says a renewed appetite for risk following a thawing of the ‘Grexit’ impasse between Greece and its eurozone creditors, muted inflation concerns and the prospect of rising US interest rates are the main reasons to expect a prolonged bear market for gold.
“Gold has historically been seen as a store of value and a haven for capital in times of tension; at the moment, however, the pendulum has swing back the other way. With Greece passing austerity measures last week, receiving bridge financing to meet its immediate obligations and reopening its banks the risk of an imminent Grexit has passed for now,” he said.
“Political tensions around the world also appear to be easing with the completion of the Iran nuclear deal and the US burying the hatchet by reopening diplomatic relations with Cuba.”
“Gold, as the world’s premiere hard asset currency, has historically been seen as a hedge against inflation. Because energy prices are a significant component of inflation measures, falling oil means that headline inflation looks likely to remain subdued for some time.”
He says as gold is priced in US dollars and habitually trades in the opposite direction from the currency, it is also not likely to rise if interest rates hikes lead to continued strength for the dollar.
“Federal Reserve chair Yellen indicated in testimony she still expects rate lift-off this year, while Monday morning St Louis Fed president Bullard indicated he sees the odds for a September lift-off above 50 per cent,” Cieszynski added.
“Increased prospects that the Fed may start raising interest rates as early as September has driven USD higher against many other currencies, including gold.”
Simon Smith, chief economist at currency broker FxPro, is sceptical about any snapback in gold and adds that investors should think again about including it their portfolios.
“I still think we are in a bear market, largely because a rising US currency and rising real interest rates is a backdrop against which gold will struggle, even after the losses of recent years. These simple facts will continue to dominate any other irrational arguments,” he explained.
“Because it strays into the realm of portfolio allocation, is non-yielding and is of limited industrial or commercial use, there is very little basis for valuing it.
Economists at Capital Economics disagree and are expecting a recovery in the price in the short term due to higher demand from consumers in India and China as well from the Chinese central bank.
“The confirmation that China has boosted holdings since 2009 has even been interpreted bearishly, as the amounts bought were actually less than might have been expected given the increase in total foreign reserves over this period,” the macroeconomic forecasting consultancy said.
“However, the still-low share of China’s reserves held in gold leaves plenty of room for further accumulation. Demand from households in China and in India should also resume its upward trends.”
“We therefore continue to expect the gold price to rise over the next year or so, although the markets may have to adjust fully to the prospect of higher US interest rates first.”
Some fund managers have seen the jettisoning of both gold and gold mining equities as a buying opportunity such as Investec’s Alastair Mundy (pictured), who in typical contrarian style has been building up exposure this year.
Several gold ETFs now make up about 10 per cent of his £2.3bn Investec Cautious Managed fund.
While the fund is up – just – in 2015, the recent falls have clearly weighed on performance in the last few months with the fund falling below the IA Mixed Investment 20%-60% Shares sector average for first time this year.
Performance of indices in 2014
Source: FE Analytics
Christophe Donay, chief strategist at Pictet Wealth Management, says the outlook for gold is negative but the short-term sell off is overdone.
Clearer signs from the Fed last week that a US interest-rate rise will come before the end of 2015 are bearish for gold.
“However, the depth of the sell-off looks to have been the result of a short squeeze magnified by illiquidity. The sharpest falls occurred when most markets were closed and the impact of stop-loss sales was magnified by a lack of liquidity,” he said.
“We see a bearish run for gold continuing on a six-month view. But with Fed tightening likely to be only gradual, the downwards pressure on gold could recede after the first rate hike.”