Monday, May 17, 2010

Gold and Interlinkages: A Commentary

2 days back Micheal Aronstein of MarketField AMC was echoing the sentiment being felt in the market when he remarked that he would consider the setting up of the Gold ATM in Dubai as a sign that things have got really odd w.r.t Gold. I agree because Gold has indeed behaved contrary w.r.t the other major variables like stocks, currency etc.. for a number of reasons. While the reason for 'safe haven' investments remain convincing for many, bubble situation in the bond market and the heating in Gold is unsettling.

I am all for Gold being a part of the portfolio. My ideal portfolio will have 4-5% Gold in it. As Businessweek notes, "It's true that gold kept pace with inflation in the 1970s. The annual increase in the consumer price index averaged 9.3% from 1973 through 1981. The market price of gold at the end of 1972 was $63.91, rising to $456.90 by the end of 1982. That's a 615% increase, compared to cumulative inflation from 1972 to 1983 of 138%". While I am sceptical of Gold being an inflation hedge, nevertheless I consider it a prudent part of any diversified portfolio.

Arguably, gold's record as an inflation hedge has been at best mixed in the long term. Data from Bloomberg shows that gold fell from 1980 to 2001 with the metal's total appreciation from 1972 to 2001 was just 337%. That barely beats inflation over those 29 years of 323.7% and is way behind the 2,466% return of the broad Standard & Poor's 500-stock index if dividends are included.

 When I was writing my Analyst report in Mongolia, I used Kitco's data to talk about 'Coiled Spring' momentum in Gold (Chris Dahaemer is a strong proponent of the same). I had given a range of 1250-1340 US$ for gold during May 2010- January 2011. Now,  Gold spot prices hit a record of $1,243.10 per ounce in Comex trading on May 12 before slipping $13.90, or 1.1 percent, to $1,230.10 on May 13. In the past three years, the precious metal is up 80%. But it has behaved in a volatile manner as the charts indicate.

While I think Gold still has some upside, the bubble mentality has become too big to ignore.
The fiscal crisis in Europe, high deficits in the U.S., and fears of inflation might be justified As Money Manager elser says, Unlike bonds, no one pays interest to holders of gold. And, unlike insured bank deposits, there is no guarantee of your principal investment and simply put no downside protection.

Opinion: At best in my opinion, Gold is a trading tool in a difficult market esp when the yield curve is flattening. Right now, with the ISM the strongest since 2004 (>60) and earnings, macropicture looking up, the yield curve should stay normal indicating sustained belief in an economic upturn.

I would say considering the info. above, Gold could be in for a correction of 10% or above in the downward direction in the next quarter

The movement of 17% in the VIX and the fall in Crude to 72 US$/bbl is indicative of fears in Europe rather than issues with fundamentals...

Tailpiece: Focus on the stretch between November 07 and September 08 and again on the stretch between Dec'09 and May '10. The metal has seen swings in excess of 10%.

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