Last updated: 11:47 / Monday, 24 June 2013
Henderson's Bill McQuaker

Loved to Loathed

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Loved to Loathed

Investors’ love affair with gold has cooled. As always, deteriorating performance has precipitated the change of mood. Gold has fallen around 24% since October last year. This disappointing outcome has felt all the worse because almost everything else has risen since European Central Bank president Mario Draghi assured us that the euro would last forever.

After roughly 10 years of rising prices, perhaps investors had grown complacent. The fact that many were recent converts to gold’s appeal meant there were plenty of weak holders liable to be shaken out by poor price action. An unfortunate set of circumstances – several near simultaneous bearish reports from investment banks, coupled with rumours of clumsy selling in derivative markets – did just that, and set the rout in train. So much for the sanctity of the safe haven asset.

Looking ahead, the short-run behaviour of gold is likely to be determined by the state of investor sentiment and positioning. Following the recent sell-down, both of these favour a stabilisation of the gold price: a high level of bearishness among investors is currently allied with significant short positions by speculators. That said, technical analysts point to $1500/ounce as the level gold must reach before downside risk has diminished in their eyes. Technical analysis has its limitations, but it may be a little more influential than normal in a market such as gold, where the asset is famously difficult to value.

Figure 1: Speculators short; investors bearish

 No of contracts                                                                                    US$

Source: Henderson, Bloomberg, Thomson Reuters Datastream; London gold bullion in US dollars; Commodity Futures Trading Commission, non-commercial short contracts; Weekly data 31 December 2006 to 18 June 2013.

Many investors, ourselves included, have viewed gold as an asset that has interesting hedging properties in an uncertain world. The unprecedented wave of central bank ‘money printing’ that has occurred in the wake of the global financial crisis may produce some surprising outcomes in the longer term, even if the bankers would have us believe otherwise.

In a world where a sizeable group of investors still fears eventual deflation, and believes that this will lead to a further bout of aggressive money printing, gold seems like an appealing store of value. Likewise, another camp of investors favours the metal for quite different reasons. They fear inflation is the inevitable consequence of current central bank policies and view hard assets (those with intrinsic value), including gold, as one of the few refuges available for the tough times that, they believe, lie just around the corner.

The last 12 months has suited neither group. The consensus appears to believe that the central banks’ actions will produce the best of all possible outcomes – accelerating non-inflationary growth that will facilitate an ‘elegant’ exit from unconventional monetary policies, and eventually, higher interest rates. In this scenario, the one thing you don’t want to be holding is an asset with no exposure to growth, paying no yield.

In recent times we have been willing to give this view a chance. Our positioning has favoured risk assets such as equities and we have de-emphasised portfolio hedges, including gold. But the going is becoming tougher for that stance. Increasing evidence of a sustained private sector recovery in the US, (especially if it happens when the effects of the ‘sequester’ begin to fade) will surely precipitate a change in the interest rate environment. That could be the worst outcome for fixed income, which hasn’t yet suffered a meaningful setback. If the prices of goods and services remain stable as growth picks up, gold will remain unloved, but any signs that accelerating growth is igniting inflation will renew interest in hard assets and gold.

On the other hand, if global growth forecasts continue to decline steadily as they have done for two years now, and inflation falls even further than it already has, then the deflationists will re-emerge, emboldened by the data. The reaction function of the world’s central banks to such developments is well-established – more money printing. Gold would be back on the bid in such circumstances.

For now we continue to enjoy the ‘Goldilocks’ backdrop (ie, growth is neither too hot nor too cold). If policymakers turn out to be truly brilliant, or if the organic, biological nature of capitalism proves up to the task of generating a renewed cycle of sustained non-inflationary growth, then there will be little need for gold in investors’ portfolios. Right now the market appears to be looking on the bright side. For our own part, we are not so sure and so gold remains a part of our strategy. Like most people, we look forward to the day when we no longer feel we need gold. It just hasn’t arrived yet.

By Bill McQuaker, Head of Henderson Multi-Asset

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