Why investors shouldn’t buy into the gold panic

There’s no two-ways about it, the last couple of weeks have been very tough for precious metals. After rallying to USD $1,580 on April 5th due to a terrible report into the state of US unemployment (see LJ blog), gold prices have fallen steeply in an almost uninterrupted fashion, culminating in a fall below USD $1,350 on Tuesday the 16th April.  Since then, Gold has recovered somewhat to USD $1,430.

The sharp fall was due to a number of reasons, including
• Goldman Sachs issuing a report telling clients to ‘short’ (or sell) Gold
• Cyprus maybe needing to sell its Gold to pay for its debts
• Traders going ‘short’ the metal in the hope of making a quick dollar as prices fall

                                                                               digitalmoneyworld

In total now, since August of 2011 gold prices have corrected some 30% - a correction very similar to that which occurred throughout the GFC, when Gold fell from roughly $1,000 USD to USD $700. Whilst the reasons mentioned above did cause an undeniable selling panic, we’d make the following observations.

Goldman’s (and other investment banks) have typically been bearish on precious metals for years, always projecting lower prices out into the future. Regarding Cyprus, considering the amount of money they (and other indebted nations, including the USA) owe, selling gold today would barely make a dent in covering their debts. Finally, whilst traders can (and for the moment are) making money when markets fall, it is a short term proposition. Those traders must reverse their positions eventually.

Therefore, just like in 2008 when a 30% correction didn't spell the end of the gold bull market, we don’t see the current bout of selling ending it either, and we think investors will do well maintaining some exposure to precious metals.

The basic rationale for investing in precious metals is to protect your wealth. Holding part of your portfolio in gold in environments of extreme economic stress and uncertainty (like the one we are in now), acts as a  hedge against other parts of your portfolio, protecting your overall wealth. Doing this will typically require investing a meaningful allocation of your portfolio to gold, but will still leave the lion’s share of your assets available to be invested elsewhere.

As we write today, some 5 years on from the GFC, we are still in an economic environment that is drowning in too much debt. On top of this we have governments around the world running historically unprecedented stimulus programs, and we have central banks printing trillions of dollars a year, all in the name of keeping the economy going. These are signs of economic desperation, not strength.

The end result of all this intervention hasn’t been that the real economy is improving in any meaningful way on a global basis. There is evidence of this everywhere, including US employment, consumer confidence and retail sales, Spanish and Dutch housing prices, Australian employment and Japanese industrial production, all of which have disappointed of late.

What the money printing has done though is pushed up asset prices across the globe, with US equity markets at all-time highs, and bond markets around the world more expensive than they have ever been. On top of this, we have cash rates at 50 to 100 year lows globally.

Whilst  mainstream financial media, many asset managers and financial advisers would encourage people to cash in gold , casting one’s mind back to the GFC highlights clearly the very real risks of ‘following the herd’.

For the last 10 years precious metals have been the best performing major asset class on the planet, and provided portfolio diversification. Until we see governments behave more responsibly with their finances, a normalisation of interest rates, a deleveraging of our financial system and an end to these historically dangerous money printing exercises, we believe gold will continue to play a key role in any genuinely diversified portfolio, despite the sometimes uncomfortable short term volatility.