Mauro Tibone, EBX Columnist

Gold Price Tumbles From Multi-Year High. End Of The Line For The Secular Bull Market?

Mauro Tibone, EBX Columnist

Over the last few centuries, gold has earned its status as the King of precious metals. Although its relevance as a currency has disappeared in our modern age, its reputation as a store of value and as a hedge against the risk of loss in purchasing power is hard to shake.

This is despite the fact that gold has little intrinsic value and differently from financial or real estate assets, does not generate any income, interest or dividends. Ask anyone if they would rather own $100,000 in cash over the next 30 years or the equivalent value in small ingots (provided they could be safely stored), I am confident that gold would win hands down.

Rightly so, I might add… but probably only if you held it for a very long time. In the last 100 years, gold has come a long way from a government-imposed value of $20,67 per ounce, to reach an all time high of $1,920 in September 2011. By comparison, yearly inflation in the USA has averaged at about 3,4% over the last century. Based on that, the buying power of an ounce of gold in 1913 would be equivalent to $486 in today’s money, making an investment in gold back then really look bright and shiny!

Between 1913 and 2013, there have been times when the gold price was set at predetermined levels. In the USA, it has been free to fluctuate, only since 1971 when the Bretton Woods system (that is the convertibility of gold against the US dollar) was unilaterally called off.

Since 1913, the gold price increase has often more than surpassed the official rate of inflation, but there have also been decades when its price has been falling both in nominal value and relative value. Gold bulls would note that the ratio between the gold price and the CPI (Consumer Price Index) generally averaged between 2 and 3 times.

Remarkably, in 1980 when we witnessed the stratospheric rise over $850 per ounce (in today’s adjusted price, that would be equivalent to over $2,500, versus the all time high of $1,920 in 2011), the gold/CPI ratio was very close to the same level of 8 that we saw recently, after having risen 6 fold for over 12 years.

Hence, it is no surprise that the gold price’s sudden fall by about 15% in the last week has drawn enormous attention from investors and the media alike, in an almost tumultuous effort to understand what is going on and why this is happening now.

Conventional wisdom in equity markets dictates that when an asset falls by over 20%, it enters bear-market territory. With gold over the last 12 years, we have hardly ever really heard any talk of a bear market, although an accurate analysis of its price over the same period shows there have already been 7 corrections in several calendar years, one of which actually went as far as almost 30%.

That did not stop the gold price from soaring, primarily on the back of the perceived protection it offers against the expansionary monetary policies undertaken by monetary authorities around the world and the growing notion of gold as an alternative asset class, uncorrelated to other markets.

Gold ownership is nowadays more broad-based, if compared to the previous gold ‘bubble’ of 1980. This is because institutional investors and individuals have been able to pile up on gold, partly thanks to the adoption of new financial instruments such as ETFs or ETNs investing in physical gold. These instruments made gold ownership far more accessible and cheaper than trading physical gold or futures, the domain of institutional investors. Gold as an asset class is believed to comprise no more than 3% of investors’ total assets worldwide, which could be seen as a possible supporting factor in the long run.

Regardless, in the near term investors’ sentiment and central banks behaviour are the primary forces behind gold price formation.

This is important, because in order to understand how gold price moves, we need to differentiate it from other commodities used for industrial purposes or consumption, such as copper or grains. Gold for industrial usage has a limited scope in the context of its marketplace, as probably only about 400-500 tons out of roughly 2,500 officially mined yearly worldwide are being consumed for commercial purposes.

If we compare this amount to an estimated 152,000 tons held by central banks, we can safely say that the large mining conglomerates will only be marginally able to affect the gold price by winding down new or existing mining developments.

Even if top producers can be somewhat profitable with a gold price of $1,000/1,100 per ounce, it is my opinion that the financial community and emerging markets’ central banks willingness to increase their reserves with a long term strategic goal will likely determine the price of gold in the future.

Given these premises, it should not be surprising that the rumoured large institutional sell order (a hedge fund?) that hit the markets on Friday April 10th triggering the start of this sharp downfall could have been in the range of 500 tons, wreaking havoc on a marketplace that offers no circuit breakers in case of panic selling.
Alternative theories behind last week’s rapid decline seem to indicate other factors at play. Among them, timely reports from influential investment banks, such as Goldman Sachs and Citigroup, are calling the end of the secular bull market for gold.

It has also been mentioned the likelihood of Cyprus selling its reserves (speculating that other Eurozone large gold-holding countries could follow suit) in order to raise liquidity for their bailouts. Finally, even a farfetched story, such as a plot by the US authorities to weaken the gold price in order to support the value of the US dollar (generally tends to rise during periods of weaker gold prices) has received wide audience.

Maybe the concatenation of all the abovementioned events formed the perfect storm for gold. But in all likelihood, the real determinant factor was that after long years of almost unabated rising, the market has come to realise that inflation is not yet materializing significantly in the world economy and actually there are signs of deflation manifesting in several countries.

Given the historical evidence of the gold price/CPI ratio, it is my view that the market has come to realise, especially since the start of 2013 (during which time gold underperformed massively, versus other asset classes) that gold had gone a long way in terms of more than discounting the prospects of inflation created by expansionary monetary policies.

Maybe the return of inflation is only a couple of years away and gold will come roaring back again, but in the meantime, short of a likely near-term bounce, I would suggest caution at jumping on the ‘gold bugs’ bandwagon. Gold has time and time again shown that it can undershoot any attempt to determine its fair or intrinsic value and it remains a great asset to hold during times of great fear.

On the other hand, given the still lofty levels that gold is trading at, I have doubts that gold can be an effective hedge against inflation… Unless you are prepared to keep it and leave it to your grandchildren!


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