Gold Gets Dumped Badly!
14 Billion Dollars Wiped-Off
The ASX on Tuesday…
Wall Street Plunges 265 Points
…time to f!#k everything and run?
No… stick with me, I’ll chart a course through the minefield for you.
There are opportunities everywhere.
There’s a massive realignment in markets happening right now.
The first phase of a great re-balancing is already underway. The second phase will be arriving shortly.
So get ready. Get on the wrong side of the re balancing and you could get squashed. But play your cards right and it will be sunny days.
So what’s going on?
Well, the first thing to take note of is the hammering the gold price is copping right now.
And I mean right now.
On Tuesday the gold price fell another 10 percent – down $149 to $1352 an ounce. It’s the biggest single fall since gold started trading in 1974. Gold has fallen about $300, or 18 per cent so far this year, most of that in the last three days.
What on earth has happened to gold’s golden run?!?
Through the GFC, between the collapse of Lehman Brothers, and a peak in September 2011, the price of gold almost tripled. It generated an annual rate of return of 37 percent a year!
Growth rates don’t come along like everyday. In fact, generally only during a bubble. That should’ve sounded some alarm bells, but it didn’t.
But to understand why the price of gold got so high, you need to understand the unique nature of the gold market.
If we go back to Economics 101, the text books will tell us that price is always driven by “supply and demand”.
But if you look at the numbers for gold, there’s a puzzle.
New mine production of gold is around 2,400 tonnes a year, while a further 1,400 tonnes is recycled from old jewellery and so on. This brings annual supply to around 3,800 tonnes a year.
On the demand side, jewelery demand is worth about 2,600 tonnes a year. Gold also has some high-end industrial and manufacturing uses. Douglas Adams famously had several metres of solid gold speaker cable in his house.
(Note to self: pick up some solid gold speaker cable from Harvey Norman.)
But if you add that together you only get 3,100 tonnes.
So you have an excess of supply worth around 700 tonnes a year.
And if we go back to economics 101, if there’s an excess of supply, then the price should be coming down. So what else is missing from the picture? How do we make up the difference?
Well, gold also some good job references from the days when it used to be money. The central banks own an estimated 31,600 tonnes. The top ten alone own 21,400 tonnes. The Fed has 8,133 tonnes, while the German Bundesbank owns 3,391 tonnes.
And what do they do with it? Well, they just sit on it. They keep it as an insurance policy against collapses in the economy, or attacks on the currency.
And so central bank demand, particularly from emerging economies in recent years, makes up for some of the short-fall in demand.
However, with so much of it just sitting around in their vaults, even if they decided to unwind only a small fraction of their positions, it could send gold prices even further south.
But that doesn’t get us all the way there. The missing, and most important ingredient is investor demand.
But the term “investor” is generous. Gold isn’t an investment. It doesn’t do anything. You can’t earn rent on it and it doesn’t pay dividends.
And so our investors are actually either hedgers, or speculators.
Traditionally, gold gives you a hedge against economic calamity. When economies crash, and your productive assets stop producing, gold is a safe place to hide your money and ride out the storm. When you’re worried about inflation getting away from you and the currency collapsing, gold can serve as a store of value.
This is was drove the first leg of the GFC bull run. It seemed like there was a real possibility that the whole western economic model could come undone. Gold offered the only protection in town.
However, hedging demand was soon followed by speculator demand – those people who were making a bet that things would get worse before they got better, and that the price of gold would keep going up.
But the speculators drove things too far. The global economy still has issues, but it seems like we’ll keep ‘muddling through’ at worst, and if the brighter tone of data is anything to go by, we could actually see things pick up pretty quickly and get the whole show back on the road before you know it.
But the gold price had come to reflect an economic catastrophe that was never going to happen. According to research out of Societe Generale, recent gold prices implied US inflation of 45 per cent per annum for the next five years (not in your wildest dreams).
And everyone in the market it knew it. And with the speculators miles too long on gold, a lot of eyes were looking nervously to the exits.
And that’s why there’s no real good explanation for the current tank in gold prices. Maybe it was weak Chinese data, or something in the FOMC comments. But nothing comes close to satisfactorily explaining the huge drop in prices.
— except nervous speculators rushing for the exits. Classic herd behaviour.
The global economy is clearly coming out of the wilderness and banking on total economic collapse is a foolish bet. I reckon we could see gold prices fall a lot further yet.
But that’s just the first phase of the great re balancing we’re in the middle of.
In the second phase the defensive positions that have driven returns over the past few years will be completely unwound. Following the GFC, a lot of people pulled money out of the markets, and put it into gold or held it in cash.
However, now that the outlook is firmer, that money will start coming back into the market. We’ve already seen a lot of cash positions being unwound. Now we’re seeing it in gold.
And as these defensive positions are unwound, it will drive up demand for those performance assets that have had a rough couple of years – stocks and property.
It’s all going to generate massive momentum in returns. Stick with me and I’ll show you how you can cash in and ride the shift of balance all the way to the bank.