Gold: Warning for investors chasing short-term gains

Gold: Warning for investors chasing short-term gains
The scale of the recent moves in the gold price and the resulting publicity are reasons for caution.

Daniel Sacks of Investec Asset Management
Last Updated: 3:56PM GMT 03 Mar 2009

There is no doubt that gold is getting a lot of coverage in the media, among global macro investors and the real money community. The suggestion is that everyone is "long" – expecting the price to rise further – and that the move has become overextended on both an absolute and an historical basis.

However, while it is true that gold has reached record highs in most currencies, it is still $70 below its dollar high reached almost a year ago and, when adjusted for inflation (CPI), the high point reached in 1980 is the equivalent of over $2,500 an ounce.

The gold price may well continue to suffer further short-term falls as part of a general upward trend, as has already been the case during this rally. However, it does not appear that we are approaching the stress point that a market often reaches near the end of a sustained price move as the graph becomes parabolic.

Indeed, the positive gold price trend is being tempered by the drop-off in Indian and Middle Eastern jewellery demand flows. Conversely, as jewellery manufacturers’ stocks decline, their willingness to buy the dips may diminish the downward moves of gold.

Gold behaves like a currency – it can be traded globally at the same price and has adequate stocks to back it up – yet it cannot be printed. It must be mined at a cost. It is hence a real asset, which generally holds its value in inflationary conditions. Gold has typically done well during periods of rising inflation and negative real interest rates.

The only episode approaching the severity of the current recession and the accompanying shock to net worth came in the aftermath of the first oil shock of 1973-74. That led to negative real interest rates at the short end of the curve in the US for five years, to higher inflation and ultimately to a major bull market for gold. Encouragingly, the current gold price is still about 60pc below its mid-1980 peak in real terms.

Gold appears to be benefiting both from being the traditional hedge for inflation hawks (some of whom are now beginning to worry about the risk of hyperinflation) and from the mistrust of some investors towards cash assets and government obligations during the current financial crisis.

It would probably require only a minority of investors to believe that they need to continue to allocate more towards gold to have a significant price impact.

Even though inflation risks remain low in our view, we believe that these forces are likely to continue to support gold prices.

Daniel Sacks is co-portfolio manager, Global Gold and Precious Metals at Investec

http://www.telegraph.co.uk/finance/personalfinance/investing/gold/4931336/Gold-Warning-for-investors-chasing-short-term-gains.html


Comment: A highly speculative asset for the uninitiated.