Gold’s meteoric rise from under $300 to a peak of $1,900 in 10 years was a perfect storm of factors driving the precious metal higher.
The psychological prompts included global investors going “risk-off” as the financial crisis took hold, excessive easing from the Federal Reserve sparking fears of a devalued dollar and EU fiscal woes inciting a quest for alternative currencies.
Then there were the hard demand drivers, including emerging markets like China and India seeing strong physical demand by consumers, foreign central bank demand for gold and of course ETFs like the SPDR Gold Shares (GLD) allowing easy access to this momentum trade.
But of all the factors behind gold’s rise, not many remain. And in place of the bullish drivers are some significant challenges ahead for gold prices based on the current environment.
Here are the major headwinds facing gold in 2013 that will keep the precious metal under pressure in the near-term:
Like it or not, inflation is under wraps. That means a low ceiling on gold prices for now.
Inflation naturally means materials prices move higher, but inflation as measured by the Consumer Price Index is at a meager 2.1% annual rate and last month prices barely budged according to the Bureau of Labor Statistics.
Gold has been mirroring trends across the commodities market, where oil prices struggle to stay above $100 and well below their 2008 peak while base metals like copper and aluminum remain soft amid weak demand.
Inflation is a big motivating factor for goldbugs, and it just isn’t a factor right now.
One of the big reasons inflation is under wraps is that the U.S. dollar remains strong, with investors around the world showing big confidence in America’s debt as a safe haven in these challenging times.
That might not sit well with investors who think that central bank policies at the Federal Reserve are irresponsible, including $85 billion a month in bond buying known as “quantitative easing.” But that’s the reality — especially as nations like Japan are actively devaluing their currency to boost exports, making the dollar more attractive by comparison.
Consider that the U.S. dollar index — a measure of the greenback against a basket of currencies including the Japanese yen and the euro, among others — hit a three-year high just a few weeks ago.
The dollar is strong, and that means dollar-denominated commodities like gold will have trouble moving up unless there is outsized demand to boost prices.
Gold Fund Redemptions
The securitization of gold that made it so attractive and easy to buy during the crisis is also making it easy for the masses to cut and run.
The landmark SPDR Gold Shares continues to tally record outflows. The bullion ETF suffered another $1.8 billion in redemptions for June; GLD has lost more than 40% of its entire assets this year with total redemptions of $12.6 billion.
When GLD suffers redemptions, it has to sell the gold it owns — otherwise, how could it return money to investors who have quit the fund? So what we are seeing is the ultimate margin call on gold, resulting in cascading redemptions that send prices lower and cause more people to sell, resulting in more sales and more declines.
Miners Will Keep Up With Supply
A key argument that gold has hit support is the idea that miners are breaking even on production costs and will not be willing to extract more metal from the ground — thus limiting supply and boosting prices.
However, it’s willfully naïve to think that major miners like Barrick Gold (ABX) or Newmont Mining (NEM) are just going to stop. They have payrolls to make, operations that require maintenance and — most importantly — debt to service. Consider that Barrick had $14.7 billion in total debt as of its first-quarter earnings report, which isn’t going to pay for itself.
Like it or not, these companies will continue to mine simply to keep the lights on, even if it’s not in their long-term interest — which is one of many reasons that gold miners are a bad investment right now.
Demand Still Soft
Many goldbugs like to focus on demand for gold jewelry in Asia and coins from the U.S. Mint. However, despite increased demand for these market segments, overall demand continues to drop.
The World Gold Council estimated that in Q1 (its latest data), overall demand dropped 13%. That trend seems to have continued in Q2 based on big redemptions at ETFs like GLD and stable-but-not-dramatic growth in the overseas luxury market. The latest headwinds include “lacking” Asia demand and import restrictions in India stemming demand there.
It’s not like nobody is buying gold, and the precious metal is always in favor somewhere. But the buyers just aren’t as eager as the sellers in this environment.
It’s hard for any investor to consider gold a risk-off investment again after the April rout in prices and the subsequent plunge below $1,200 in late June.
And even if you could make that case, why would you choose a defensive strategy with the S&P up about 18% year-to-date in 2013?
Even if the market does see a mild correction, which could happen after some lackluster earnings lately, it’s hard to imagine global investors getting so jaded with U.S. equities that they plow their money into gold once more.
Like it or lump it, gold is a divisive asset class and the investment is driven largely by emotional arguments.
After all, it’s not like there is much practical use for gold (barring the limited industrial and technological applications for the commodity, of course). Thus, the market is based inherently on speculation, greed, fear or whatever other sentiment rules the day.
Right now, the sentiment is decidedly against gold. And even if you don’t believe the previous arguments against gold and can offer up some rational counterpoints to make the bullish case, that may not matter.
Because right now, the bears are winning the emotional argument — and that counts for a great deal when it comes to gold.
Jeff Reeves is the editor of InvestorPlace.com and the author of “The Frugal Investor’s Guide to Finding Great Stocks.” As of this writing, he did not hold a position in any of the aforementioned securities. Write him at firstname.lastname@example.org or follow him on Twitter via @JeffReevesIP.