Investors rush out of ‘safe haven’ gold

26th September 2011

Anyone who bought gold at its September 6 peak – around $1,920 – has lost around $300 an ounce. That's a bigger fall than most equity markets over the same three- week period.

For some it was even worse. Overnight, prices plunged to around $1,536 an ounce in Far East markets, where physical gold purchase is concentrated, before bouncing back on bargain buying.

Investors who bought at the peak and sold at last night's low point could have lost some $383 an ounce. All those kilobars and 24 carat bangles are now worth some 20% less than a few weeks ago. But they are still 16% higher than the start of the year – earlier this month the year to date figure was up 35%.

It's all a far cry from just a few weeks ago when investment banks and hedge funds were talking up the price of the yellow metal. In early August, the Daily Telegraph quoted forecasts including UBS' fourth-quarter price at $2,100 and Societe Generale's at $1,950 and $2,275 for 2012, with $2,500 for the last quarter of next year. Bank of America-Merrill Lynch was also bullish, seeing $2,000 as a 12-month target, while JPMorgan went along with SocGen, predicting $2,500 in a year's time.

But the forecasts are not all one way. Citi revised its figure for 2012 up to just $1,650 for 2012 before falling in 2013; likewise National Bank of Australia has it back to $1,600 by the end of this year and the closely followed Goldman Sachs predicting $1,645 an ounce, $1,730 an ounce, and $1,860 an ounce on a three, six, and 12-month horizon respectively.

The questions now are what has happened to the seemingly one way move in gold, will it bounce back, and, more fundamentally, is there such a thing as a safe haven?

Why has the gold price crashed?

There's a number of fundamental reasons cited for sellers taking the driving seat. These include:

·       Collapse of physical demand in India and China. They'd bought gold as a hedge against inflation but now many see a Western recession looming that will cut back on the steeply rising prices trends in their economies. And jewellery buyers can't keep on paying ever higher prices.

·       Fear of a price collapse. Investors who have held gold for some time and see the price coming lower will tend to cash in their profits fearing they will be lower tomorrow. Much gold is "non-physical" (held via ETFs or other instruments) so selling is easy.

·       Counter-attractions of other assets. Equities may have fallen sufficiently for investors to switch into shares with their dividend prospects out of gold, which produces zero income. And with many major economies close to recession, no one expects sharp interest rate rises so bonds are in demand.

·       End of the commodity story. Other commodities such as copper and silver, have also fallen sharply on demand fears as recession fears grow. Although there is no short term relationship, over time gold tends to correlate with oil, silver and other commodities.

·       Resurgence of the US dollar.  Investors are gaining confidence in the US dollar and its trade weighted value is rising in the wake of the Zurich authorities putting the dampeners on the Swiss franc. They are buying cash dollars as well as driving down US Treasury yields again with bond purchases – the effect of the Standard & Poors credit downgrade seems to have passed. And as gold is primarily priced in dollars, it tends to go up as a reaction to dollar weakness – and vice versa.

·       Gold loses safe haven lustre.  Investors have been sold gold on its safety grounds for many months. But once something safe looks risky – rather like a leaky lifeboat – investors will react and seek a new place of security. There is no such thing as a permanently safe home.

Where is new safe haven?

Occupational psychologist and Mindful Money blogger Kim Stephenson is clear that the safe "safe haven" is wishful thinking. He says:

"There aren't any safe havens.  It's natural for people to want to be safe – humans are primed to seek safety.  But life doesn't work like that so the search for safety is constant.

Imagine you are escaping a flood. Is a tree "safe", it depends how high the water or the tsunami rises and whether the tree falls over.  Afterwards you (and everybody can say) – you should have climbed a tree in Aberdeen (or Cornwall, or Anglesey) or whatever. But beforehand, and at the time, nobody knows.

Whatever is perceived as safer than the alternatives at the moment, will attract money – and the perception is formed by news media, opinion etc.  As people hunt around, perceptions change, everybody is constantly surveying what is going on, "experts" are commentating, media are flooding people with views.  As a result there's a constant flow of money chasing what is "safe" – nothing is safe, just relatively safer and the relative safety keeps shifting as the money chases round.  If it sits still for a few days, people start saying it is a "safe haven", like gold, more people pile in, the price goes up, it looks less of a sure thing and then the money chases something else again."

Where do we go from here?

"The bull case for gold is on pause for the near term," said Adam Klopfenstein, senior market strategist for precious metals at MF Global in Chicago.

"In the near-term, the flight-to-quality interest in owning gold is also out of the window as people are not interested in buying it even in the face of fears in the economy. Until it stabilises, I'm staying out of this market."

Neil Meader at GFMS, the metals consultancy, says the primary reason
gold was falling this time was that the dollar was rising. "The dollar and gold tend to be negatively correlated. Even though we are far from out of the woods in the Eurozone or the US, gold has suffered because the dollar has strengthened."

But gold could still come back, says Meader. He predicts gold could be worth $2,000 an ounce a year from now. For that to happen the dollar will have to weaken.

More from Mindful Money: 

Market monitoring

Investing: Where have all the safe havens gone?

Gold may glitter but can it deliver?

Diamonds: Are an investor's best friend


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