Gold – How Low Can It Go?

By Greg Tolpigin | More Articles by Greg Tolpigin

Gold has been on the back foot for several years now despite goldbugs consistently telling us to buy the precious metal as it is important hedge against inflation and the eventual demise in asset prices around the world. Both of these upcoming events were apparently meant to have occurred already due to the money printing of global central banks and as we have seen none of this has occurred.

Even in the face of some of the large global issues that have surfaced in the past three years gold has failed to rise. Both Greek bailouts, Cyprus bailouts, the deterioration in emerging markets and terrorist events have had limited lasting impact. How can so many gold bulls be wrong? After all economic theory tells us that money printing by central banks will lead to inflation and the best inflation hedge is gold.

As a gold long-term gold bear the answers are very simple and why gold will continue to fall a lot further.

Gold is an asset class just like any other and must provide a return to investors. It is speculated on and thus also is governed by the same market forces.

The first problem with gold is it provides no return. There is no yield and in fact there are holding costs involved with owning gold or gold instruments. Therefore if its capital value is not appreciating it is a drag on portfolio returns.

Now consider the fact that while you are holding gold the opportunity cost is significant. Of the kind we have seen in the past 5 years where stock markets have surged and real estate prices in the major cities of the world have reached new record heights, the opportunity cost of having money in gold is substantial. While gold has fallen bonds, stocks and property have produced some of the best capital gains of all time. As each day these assets rise is another day a gold investor switches to a better investor. That selling pressure pushes down prices.

The next issue for gold is that like any other asset class that experiences a bubble, it must deflate. It’s hard to argue that gold prices were not in a bubble when they increased from $400/ounce to $1900/ounce from 2005 to 2011 – the best run in history. The problem with a bubble is that those investors holding at the peak are long-term holders, they continue to hold believing that when they bought at the highs the bubble had more to run. If they don’t sell quickly that typically end up holding for long periods making the excuse that the fall is unjustified and then look for reasons it must rise. Everybody else who is no longer holding gold are not interested in buying anymore – the bubble has burst – and thus the lack of buying interest amplifies the downside.

Those gold bulls pushing gold hold their maximum possible position in gold – they can’t buy anymore. They are fully invested. So who is left to buy? Nobody.

And as asset prices continue to rise gold will fall further.

The interesting aspect to gold is the timing of its falls. The biggest fall in gold since the peak came in April 2013. What occurred at that time? Stock markets broke through to fresh record highs above their 2007 peaks and we had a resolution to the Cyprus debt default that surfaced in March. This was a key turning point for gold as in the new world of central banks using new measures to prop up failing economies – gold’s use disappeared and positions were liquidated and transferred to financial assets.

The fall this week in gold came after the Greek resolution and as (my long held view) that we are entering the bubble stage for equities and global property. This is the exciting part for equity investors and holdings of assets not performing are sold to fund participation in the bubble. Recall stocks like NAB fell from $30 to $20 in 1999 as investors switched to technology stocks. Other equity holdings funded purchases of speculative assets.

And that is what we have seen for the past 4 years in gold and the next nine months for gold will be very tough. I have had a target of $999 for gold since 2012 and while it has taken longer to hit that level than I have expected, it will reach those levels so don’t try and pick a low.

Greg Tolpigin

About Greg Tolpigin

Greg Tolpigin has over 20 years of experience as a proprietary trader and high-level strategist for the major investment banks including Citigroup, Bankers Trust and Macquarie Bank.

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