At an educational investment seminar in the spring of 2011, I told a group of salivating gold bugs that the price of the precious metal, which was approaching $1,500 per ounce at the time, might well go higher, but that dreams of $3,000 per ounce seemed far fetched. I went on to say that the dynamics of the gold market had changed dramatically, and that the price of the metal could easily drop 20 percent in one day due to these dynamics, which I’ll review below.
My statements were an opinion based on reasonable expectations, but certainly I don’t possess the power to predict the future. Sometimes, not often, opinions work out to be right. Gold continued to rise in 2011, peaking at about $1,800 per ounce in the late summer. After trending sideways to down slightly in 2012, gold has dropped precipitously in 2013, and is now down about 35 percent from it’s peak in 2011.
My prediction of a 20 percent drop in price in one day has not turned out to be true so far, but a 13 percent drop over a two day period this last April was attention getting. Of course, the important question for future decisions, or for those who may hold gold in their portfolio at present, is what will happen in the future.
Again, not being able to predict the future in any reliable manner, I prefer to look at the current trends, fundamental reasons that an investment may rise or fall, and the risk of being wrong. So, lets take a basic look at some of the factors to consider.
Some may reason that with gold down about 35 percent it is a bargain. Well, there is certainly less risk in holding gold at $1,200 an ounce compared to $1,800. But, that doesn’t mean the risk is gone. About 30 years ago, the price of gold rose from $35 per ounce to $800, peaking in 1980. Over the next 20 years, gold fell over 60 percent to under $300 per ounce in 1999. So there is precedent for gold to lose more than half its value, which would take it to about $750 per ounce if it were to happen again. I’m not predicting this, but it is a possibility.
The new dynamic that I think is really affecting the price of gold and the dramatic swings it is experiencing is the advent of exchange traded funds (ETFs) which make it as simple as a click of a mouse in your online brokerage account to either buy or sell gold. In the past the decision to buy or sell gold was a bigger deal. Storing the gold bars or coins was a hassle and a cost. When ready to sell you had to get the bars out of storage, carry them to a dealer, and risk loss due to theft. Now, we can buy gold in less than 10 seconds, hold it at a very low cost, and sell it in the same 10 seconds.
The gold market is now subject to the same emotional feelings of fear and greed of individual investors as the stock market is. When enough investors place buy orders for gold ETFs, it creates demand to move the price higher, but any move to sell by a large enough volume will drop the price like a rock – exactly what we have seen in 2013 so far.
There is no evidence yet of any sort of bottoming for gold and I think the risk of further decline is high. I urge caution when trading a commodity, which has relatively little actual economic value in terms of its use in production and is mostly used for discretionary items like jewelry, which is not a necessity, and other than that is just a bet on investors fears of Armageddon.
At the very least, I suggest using some sort of trend following tools to try to identify an actual change in direction of the price rather than guessing at it. Good luck, and good investing.
Tom Breiter is president of Breiter Capital Management, Inc., an Anna Maria based investment advisor. He can be reached at 778-1900. Some of the investment concepts highlighted in this column may carry the risk of loss of principal, and investors should determine appropriateness for their personal situation before investing. Visit www.breitercapital.com.