Cash is king no more... gold reigns

“Gold at $1,500 an ounce? Yeah, that’ll happen when the stars start falling from the heavens,” an investor friend of mine said recently in response to my article titled Gold price yo-yo: $1,500 to $10,000, anything is possible, which was published on Emirates 24|7 on September 14, a week after the yellow metal made its all-time high of $1,920.30 per ounce.

Last week, a satellite – admittedly, not a star – did fall from outer space and hit mother earth (Nasa’s dead satellite fall starts over Pacific) and, more importantly, spot gold fell more than $385/oz from its peak and traded at $1,531.90 per ounce yesterday even though it has since recovered almost $140 an ounce and is currently trading at $1,671.50 per ounce (1.30pm UAE time, 09.30 GMT).

The same friend quipped yesterday that he was going to buy a whole pack of Neosporin for the fingers he burnt by buying the metal close to its highs. While a number of seasoned analysts have been cautioning individuals from taking positions in gold above $1,700 per ounce, those that have entered the market recently may want to focus on the long-term potential of gold than the short-term rollercoaster ride that the ‘safe haven’ metal seems to be offering its fans currently.

For gold price, it seems it’s 2008 all over again – savvy investors will remember that right after the collapse of Lehman Brothers, spooked investors had to liquidate their holdings – stocks, bonds, commodities, metals… everything to cover their margins – and there was a mad dash for cash, which saw gold lose about 30 per cent) it fell from $1,011 an ounce on March 17, 2008, to $712 on October 24, 2008.

But from then on, prices went up by more than two-and-a-half times until early September 2011, and even at the trough of the most recent correction, were more than double the average gold price in October 2008 ($760.86/oz).

There are a few similarities between what happened then and what’s going on now in the world. In the run up of the US subprime crisis snowballing into a full-fledged global economic recession, gold prices doubled in the 26 months between January 2006 ($524) and March 2008 ($1,011). The same happened in the 24 months between September 2009 ($955) and September 2011 ($1,920), when prices doubled yet again. This may also suggest that we are at the cusp of the dreaded double-dip, as precious metal prices generally peak just before a crisis.

After the 2008 correction in October, as now, many commentators were wondering if the game was over for gold, especially as volumes quickly spiked to such high levels in the prior run up – an important indicator of coming corrections as the safe haven characteristics then become more suspect.

Analysts maintain that the corrections that follow an unusual spike in volumes are good for the market in the long run as they tend to keep speculators and uninformed investors at bay. In the short term, gold may behave erratically, as it did recently, and its safe haven status will remain in doubt.

However, in the context of the macro markets, the recent decline in gold prices should be seen in context – there are five primary reasons why the gold (and, don’t forget, silver) prices declined recently:

a) What Goes Up: Prices went up too far, too soon for them to be sustainable or even credible in the medium term;

b) Margin Calls: The New York-based CME Group raised margins on trading gold, silver and copper – for the third time in two months – with margin requirements now 55 per cent higher than what they were prior to the hikes, making it much more expensive for traders to transact in precious metals and, in certain cases, resulting in flash-sale on technical margin calls;

c) Dynamic Dollar: Renewed strength in the US dollar, which pushed everything priced in the global currency (read: precious metals and oil) lower. The dollar gained particular vigour after recent comments by the US Federal Reserve fuelled concerns about the world’s largest economy’s long-term health, and signaled to the world that interest rates on the greenback would remain low for the foreseeable future;

d) Hedge Fund Sell-off: Some of the world’s biggest hedge funds are the main culprits of this sell-off. George Soros, who last year called gold the ‘ultimate bubble’ claims he sold off almost all of his gold holdings this year. Other hedge fund managers too have been reportedly selling off gold to either book profits or plug margin calls on investments elsewhere;

e) Panic Selling: Including my friend who’s now nursing some very sore fingers, individual investors who entered the market late – or without a strategy – sold their positions when they saw gold prices dip, and in effect added fuel to the proverbial fire that engulfed the market albeit for a brief period.

There's also the fact that Indian demand remains traditionally depressed during the period of 'shradh,' which is considered an inauspicious period for gold-buying as according to Hindu mythology, this is the month of remembering one's ancestors and donating for and on their behalf - not a good period for investment or buying jewellery. This year, that 10-day period ends today, September 27, and there has already been a spike in demand from Indian traders in order to stock up for catering to the pent-up demand.

And now that the correction has happened, and prices are seen recovering, this may be the perfect opportunity for those who missed the joyride last time around to get back on the gold bandwagon. The current backdrop, reminiscent as it is of gold’s outperformance from 2008 into 2009, may be a perfect setting for that.

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