Unless something pretty miraculous happens in the next four months, gold will have its first down year (in dollar terms) for 13 years. Why has it had such a tough time?
Firstly, real interest rates have been rising globally over the past 6 months. Being a non-yielding asset, the opportunity cost of holding it is less when returns are low elsewhere. Our measure of global real interest rates (10 year bonds minus inflation) was negative late last year and in early 2013, but has since been rising (by 50bp over the past four months), making it more difficult for investors to forgo a real return for the greater uncertainty of gold. Of course, there is a link here with expectations of the Fed moving to taper the current pace of bond purchases, which has itself pushed bond yields higher.
Secondly (and naturally related), the inflationary arguments for hoarding gold have not come to fruition. Indeed, inflation has been steady or falling this year (OECD inflation measure at 4.5 year low), whilst the Fed’s preferred measure of inflation expectations (5y5y breakeven rates) has also declined. Much of the visible impact of global quantitative easing has been in asset markets, with the real economy impact to stave off deflation, rather than materially add to inflation.
Thirdly, we’ve had a catch up in terms of ETF gold selling. Whilst gold prices peaked two years ago in dollar terms, global holdings of gold within ETFs peaked late 2012. What we’ve seen this year is some catch up liquidation from this sector, with data from the World Gold Council showing ETF selling to be the biggest factor pushing down on prices in Q2.
What’s going to be interesting for the remainder of the year is China and India. Combined, they represented 50% of consumer demand for gold in Q2, even though they only represent 10% of global economic output. There are strong cultural reasons for this, which partly explains why we’ve seen demand increase as prices have fallen, even when both economies have been slowing. But the recent decline in the rupee has likely challenged than dynamic and served to curb the recovery in gold during August.
The bottom line is that the easy days are over in gold. Indeed, they have been since the peak in dollar prices 2 years ago. Gold bulls are going to have to come up with some new arguments, because at present the bullish case (inflation, quantitative easing, strong emerging market demand) are all weakening.