In The Lead – Myth-Busting 101: A Golden Dilemma


Precious Metals CommentaryThe new trading week started off on a downbeat note in commodities, equities, and a certain crisis-beset currency across the Atlantic.

Risk assets headed lower on a combination of anxieties surrounding global economic expansion (the inverse thereof to be specific), and persistent systemic troubles in the eurozone and China.

The spot price of gold fell by more than $11 to touch $1,578 per ounce while silver shed 51 cents to reach a bid-side quote at $26.87 the ounce. Friday’s Market Oracle posting by Joe Russo summed up gold’s current paradigm as plainly as can be, and as follows:

"At present, gold continues to render lower lows and lower highs, confirming its downtrend of the past 10-months."

Platinum dropped by $18 and palladium declined $8 with quotes coming in at $1,410 and at $576 respectively. Citigroup analysts have downgraded their 2012 and 2013 price projections for platinum and for palladium this morning. The bank scaled back its palladium average price forecast by 18% to $659 for the current year and by 24% (to $700) for next year.

The weekend did not bring much in the way of positive physical gold offtake reports from India. As regards that country’s gold demand for the current year, the World Gold Council finally realized that domestic troubles (uncertainty, deficits, poor monsoons) and active efforts by the government to curb bullion intake will translate into a second year of such demand falling.

As regards the current year, the semi-annual snapshot of various top investment ideas (usually concocted at the start of the new calendar) reveals that a) gold has been volatile and that b) gold price-tracking investment vehicles are "essentially flat" while gold mining shares have once again (surprise!) been slammed (down 19% YTD).

Marketwatch notes that "weak global growth is dragging on gold prices. India and China are among the world’s largest gold buyers and the slowdowns in those major economies have taken a toll on precious metals."

A very timely paper titled "The Golden Dilemma" published on June 7 by commodities expert Claude Erb and by Duke University Prof. Campbell Harvey (he also of the National Bureau of Economic Research) addresses certain "age-old" questions that continue to dog the minds of the average investor. Namely, "Do I seek inflation protection by paying a high real gold price that almost guarantees a decline in future purchasing power? Do I avoid gold and run the risk of a decline in future purchasing power if inflation surges?"

The authors set out to try to better understand the treatment that gold ought to receive when it comes to portfolio allocations. They examined a host of "popular stories" that are commonly employed to make a pro-gold argument. You know; inflation hedging, currency hedging, and disaster protection. By delving into the facts-and-figures-based reality in gold over a long timeframe, the authors manage to debunk such "conventional wisdom" line by line, in devastating fashion.

First of all, they assert, it is not plausible to expect that the real rate of return in the long-run for gold could be13 percent per annum, as it has been from 12/1999 to 3/2012 (more like 15.4% actually, minus a 2.5% annualized rate of inflation).

Second, the authors caution, "given the most recent value for the CPI index, this version of the "gold as an inflation hedge" argument suggests that the price of gold should currently be around $780 an ounce."

They also remind the reader that the only other time that the real price of gold was as high as it is currently, was back in 1980 and that periods when such real prices are above average are followed by extended periods of time when they are to experience returns below average.

As regards gold and long-term inflation, the team notes in one of their graphic exhibits that There has been substantial variation in trailing ten year annualized gold returns: from as low as -6% per annum to as high as +20% per annum. Over the same time period the low and high inflation returns were +2.3% per annum and +7.3% per annum. The exhibit suggests that gold is not a very effective long-term inflation hedge when the long-term is defined as 10 years."

We will have more on the paper’s findings in upcoming articles and we will cover other aspects that "conventional wisdom" often relies upon when it comes to gold, such as currency and disaster hedging. Suffice it to say, some surprises may be in store for the reader. We’ve noted many times here that gold essential to own in moderation as it is many, many things –a lot of them very, very good ones- but that getting carried away with shopworn slogans about it presents real risks to one’s basket of wealth.

The CFTC weekly market positioning report issued on Friday reveals "weak" conditions among bullish camp gold troops. Hedge fund players and other money stewards sliced their net-long gold positions by almost 20% in the wake of the turbulent period that led up to last Friday. As Standard Banks (SA) notes in their morning missive today, the situation

"underscores the fragility of any rally in gold at the moment, unless the market is sustained by the promise of further quantitative easing from the Fed."

The metals (and commodity) bulls may well be hoping that Mr. Bernanke’s upcoming semi-annual Congressional testimony might contain the fervently wished-for words hinting at "QE" (they’ll take any form of it at this point, thank you) but most of them realize that such a forum will not be the place where the Fed Chairman is likely to drop such hints. Thus, for the time being gold might very likely remain confined to its now nine-week long price range and taking on a more-than-neutral trading stance by market participants is seen as something that one does "at their own risk."

It remains to be seen if tomorrow’s Bernanke testimony or Wednesday’s Fed Beige Book report will suffice to break the price logjam in formation for three months now. For the moment, the markets received yet another "hot-cold" pair of US economic statistics in the form of the Empire State Index and June retail sales figures. The former came in at well-above-forecasted levels (5.0) with a reading of 7.4 for July according to the NY Fed.

On the other hand, the 0.5% drop in June US retail sales (third straight decline)a stoked the pro-QE "Fedspecting" crowd once again and it shaved 0.10% off the US dollar’s previous advance to above the 83.53 on the trade-weighted index. The news did not come as a total surprise however; as recently as Friday the betting was tilted towards softer retail sales revelations in the wake of reports from luxury goods purveyors and the U Michigan consumer sentiment survey. At any rate, by the time this goes to print, the tide in gold and silver prices might well reflect such "Fedspectations" once more.

Until Wednesday,

Jon Nadler

Senior Metals Analyst — Kitco Metals

Jon Nadler
Senior Metal Analyst

Kitco Metals Inc.
North America

Disclaimer: The views expressed in this article are those of the author and may not reflect those of Kitco Metals Inc. The author has made every effort to ensure accuracy of information provided; however, neither Kitco Metals Inc. nor the author can guarantee such accuracy. This article is strictly for informational purposes only. It is not a solicitation to make any exchange in precious metal products, commodities, securities or other financial instruments. Kitco Metals Inc. and the author of this article do not accept culpability for losses and/ or damages arising from the use of this publication. and

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