Yet again panicky investors are rushing to buy gold at a time of global financial turmoil. It seems that most of the buying of gold is done by ordinary people who are not fully aware of what is actually happening in the global financial markets or the world economy. The rush to buy gold has pushed its price up sharply this year ignoring the rout in global commodity markets. Just for a reminder that price of gold has been falling for the past six years. I believe that some of the rally in gold price has something to do with the Indian seasonal festivals and the Chinese New Year.
There is this recent argument that has been pushed around by the gold bulls. Because gold offers no yield so the ever-increasing chance of negative interest rates in the developed economies and the dramatic fall in government bond yields makes gold attractive investment. This argument does not have a chance if inflation continues to fall and deflation becomes a reality. Gold supposed to be a hedge against inflation not deflation.
Over the past 6 years gold has underperformed massively against most other asset classes. It has underperformed against, government bonds, equities, real estates and also cash. It has failed as an indicator of rising global inflation at a time when central banks around the world printing unlimited supply of money but that money has not fed through to the system. I expect gold to continue the underperformances and will continue to decline in the coming months as the global financial markets has withstood the crisis in the Eurozone, the geopolitical unrest in the Middle east, Africa and lately the North Korean threat to its neighbor and to the US.
I don’t think gold should be treated as another asset class by investors. May be just as hedge against the global financial turmoil. Since the start of the financial crisis back in 2007, analysts and commentators have aggressively recommended that Gold should be treated as an asset class on its own. These arguments contradict the historical case of holding Gold. Historically Gold is seen as a store of value against inflation and it should be treated as such nothing else. If an investor wants to hold Gold in a portfolio of a diversified asset then my advice is to hold as little as are permitted without adding any elements of speculation to the portfolio.
The only good forecast for future trend of the price of Gold is inflation. This probably should be the correct argument for investing in Gold as a future hedge against inflation. Back in 1980 when the Soviet Union invaded and occupied Afghanistan and the Islamic revolution started in Iran, Gold price hit a high of $800. Then it continued a two decades of correction till it reached a low of $300 in 2001. During that period average global inflation continued to fall and it reached around 4 percent by the end of the nineties. So, the correction in Gold price was accompanied by a global fall in inflation but it did not protect investors against inflation and it lost investors nearly 60 percent of its value.
So we can argue that historically gold acted as a hedge against inflation but not over the last few decades. The lesson for investors is that the price of gold tends to rise when there is an easy monetary policy in place and tend to fall when there is a tighter monetary policy. The recent rise in gold prices may be related to the latest rise in US rates and future expectation of further increases. But even this could be misleading in the face of weak global economic growth and threat of recession.
A recent study shows that the cost of producing an ounce of Gold is around $760, which is about 65 percent lower than the spot price of gold. As long as there is such a huge profit margin on Gold then production will continue to increase and the selling pressure will remain. Investors should be aware that all the Gold produced around the world are still in existence are ready to be sold at a certain price and there is no reason to hold on to them. My biggest fear is that gold price has peaked few years ago and it has been in decline since then. May be a price correction is overdue. How far it can correct depends on the supply and demand. Producers are happy to keep producing as long as they can have a big profit margin. There is the possibility that producers might start selling Gold forward to capture the high price and by doing so will continue the high production.
My advice is if you are investing in Gold because of your concern about the global economic and political environment then you should think again! –Rasameel Structured Finance Company.
By Hayder Tawfik