To say that the second quarter of 2013 was a bad one for gold doesn’t do the implosion justice.
So awful, in fact, that the world’s most sought-after metal took a record-breaking quarterly loss in value of 24% in Q2. Factored in with the first quarter’s 5% dip, gold has given up a whopping 28% for the year so far … a meltdown that it’s safe to say practically nobody saw coming just a few months ago.
The size and speed of the drubbing has sent traders and pundits scurrying to the extreme ends of the spectrum too. Some say this is only the beginning of the end, while others say there’s never been a better time to buy into gold or gold-related funds like the SPDR Gold Shares (GLD).
Before anyone jumps into one camp or the other, though, it might be best to take a breath, take a step back, and figure out how we got to where we are in the first place.
What It’s Not
Click to Enlarge Federal Reserve Chairman Ben Bernanke is getting the bulk of the blame for gold’s train wreck.
The nation’s central bank first started subtle chatter of dialing back its QE efforts in February. It was the May warning, however, that spooked the market into action.
That’s when bond yields started to rise, reflecting falling bond prices — the result of the Federal Reserve just mentioning the possibility that it would be tapering off its bond-buying efforts. Ten-year treasury yields ramped up from 1.6% to 2.6% in a matter of days.
Problem: Interest rates moved to multimonth highs, while gold prices fell to multiyear lows.
The same goes for the U.S. dollar. The value of the greenback has barely budged since March, while gold has lost 25% of its value.
Click to Enlarge A lack of inflation? Nope. The inflation rate (which never soared out of control, by the way) peaked at 3.87% in September 2011 and has been sliding lower ever sense. If the date rings a bell, that’s when gold started to deteriorate.
The problem is, it’s not like non-inflation is exactly a new phenomenon. Indeed, the inflation rate grew from 1.06% in April to 1.36% in May. It was the first time in months that inflation was on the rise. Although it should have, it just didn’t matter to the gold-trading crowd.
What It Is
If it’s not rising interest rates, a rising U.S. dollar or a lack of inflation that’s killing gold this year, then what, pray tell, is doing it?
Two semi-related factors:
Although the second quarter’s official records aren’t in yet, Q1’s official numbers began painting the grim picture: gold euphoria is unwinding. In fact, for some segments of the gold market, it’s already in reverse.
Last quarter, the ETF and mutual fund industry actually sold (net) 177 tonnes of gold to pay for redemptions. It was the first time the industry was a net seller of gold since the first quarter of 2011, and only the second time the ETF industry had been a net seller for an entire quarter since the Q2 2007.
Click to Enlarge Central banks also scaled back their gold-buying activities in the first quarter, only purchasing 109 tonnes of gold in Q1. That was the lowest central bank buy-in since Q2 2011. It’s also likely that the world’s central banks kept gold purchases to a minimum in Q2. Remember, part of the reason gold started to suffer in April was rumors that the nations of Cyprus, Portugal, Greece, and Japan were (for different reasons) en route to become net sellers of gold.
When it was all said and done, in Q1, total consumption of gold was as low as its been since the first quarter of 2010.
Perhaps more than anything, though, gold is going lower because amateur retail investors have finally either (1) been spooked by some uncomfortable bearish volatility from gold, (2) gotten tired of waiting on inflation to soar or the sawbuck to plunge, or (3) some combination of both.
It’s an unpopular premise to say gold’s heroic rise through 2011 was driven far more by hype than substance. In retrospect, though — and against a backdrop of a 30% plunge in gold prices — it’s getting tough to say the selloff is being spurred by level-headed professionals and disciplined central banks. The size and speed of the selloff screams “amateur investor,” and there’s no telling when or how that emotionally driven trend could end.
The fact that the ETF industry had to fund a massive degree of gold-fund redemptions in the first quarter speaks volumes.
The history is all academic at this point. The question investors are asking now is what’s next.
First and foremost, know that with a current price of $1,200 per ounce, it’s costing many gold miners more to dig the stuff up than it can be sold for. Iamgold (IAG) for instance, reports an “all in” average mining cost of an average of $1,395 per ounce. Goldcorp’s (GG) total cost per ounce was $1,135 as of March. Thomson Reuters reports the average cost per ounce for established, operational miners in 2012 was $1,150, which is going to make it tough for the industry as a whole to turn even a small profit. That spells trouble for industry-wide funds like the Market Vectors Gold Miners ETF (GDX), unless gold makes a huge — and sustained — recovery. On that note …
With the recent plunge to $1,200 per ounce, gold is officially oversold and ripe for a bounce. It’ll likely get it, too. The move should last a few weeks. By the time Q3 ends and Q4 begins, though, odds are that traders are going to notice a lack of inflation; if the Fed’s easy-money environment didn’t cause it, any talk of tapering the current QE effort certainly isn’t going to make it happen either.
The U.S. dollar isn’t in any position to crumble either. Indeed, other nations are making a point of keeping the sawbuck strong by keeping their currencies weak in an effort to spur exports (from there, to the United States).
Click to Enlarge Worst of all, though many retail investors have dumped their gold position recently, many more are still in their gold trade, but only just barely. The higher gold bounces, the higher the odds these remaining stakeholders are going to use that strength to sell into, keeping prices tempered if not outright pointed lower.
Gold is apt to rebound back inside the $1,335/$1,460 per ounce range in the second half of this year, but that’s a purely technical bounce. After that, the underpinnings we see falling into place right now — like an improving dollar, tepid inflation, and central banks that are losing interest — pave the way for even lower gold prices.
As of this writing, James Brumley did not hold a position in any of the aforementioned securities.