A good example at present is thermal coal, where a massive ramp-up in production since 2000 led to an oversupply situation, exacerbated by prices falls and lower demand in the post-GFC period. While price and demand recovery is still a couple of years away, the world’s major thermal coal producers have implemented production cuts over the past three years that have led to a stabilisation in prices and ultimately will lead to modest price recovery.

The situation in the iron ore industry is vastly different. Rather than reacting to plummeting prices with significant supply cuts, Rio Tinto and BHP Billiton have continued with their implementation of new mine expansions, further dampening prices.

The rationale for this is threefold: firstly, they can weather the iron ore price downturn because they’re used to operating at even lower price levels (as evidenced by the price chart below); secondly, it’s a great opportunity to drive competitors to the wall; and thirdly there’d be a huge loss of face in reducing output after hundreds of millions of dollars have been spent on expanding infrastructure over recent years.

The lower prices of iron ore have appeared to be inevitable for much of 2014. Supply side growth has looked likely to outpace demand growth in China, and steel production has been slowed as the government looked to tackle over capacity in the industry.

So the medium-term outlook for iron ore producers isn’t hugely appealing. Chinese steel production is expected to moderate due to a combination of slower macroeconomic growth rates and transitioning away from investment-led growth to consumption-led growth. All of this will coincide with a sizeable growth in world iron ore supply between 2014 and 2018.

Global iron ore exports are expected to increase by 10% (or 144 Mt) during 2014, whilst the period from 2015 – 2018 is also expected to generate continued strong growth, with annual supply increasing by 5.7% (or 88 Mt). This growth will essentially be led by the Big Four miners, which are expected to average 85 Mt of annual production increases for 2013 – 2015, compared to 45 Mt average annual growth during the course of the previous decade. The chart below highlights the location of new sources of iron ore supply:

In terms of the pricing outlook, iron ore prices are likely to trade between $140 on the upside and $110 on the downside, but with an overall weakening of prices. The reason is that supply is growing to meet demand, meaning the iron ore market surplus will most likely expand. This surplus is forecast to persist during 2015 and 2016, driven by continued large supply increases out of Australia and Brazil combined with slower steel production growth in China.

The iron ore business has for decades been dominated by three major players – Rio, BHP and Vale – which together have accounted for as much as 80% of the world’s seaborne iron ore trade. There’s a simple reason for this – iron ore is a bulk commodity, which means it’s typically a low-margin business, requiring mining and movement in enormous volumes to generate a reasonable profit. Being a bulk commodity, infrastructure costs are huge, with returns typically generated over a significant period of time.

The fundamental characteristics of the iron ore business – high capex/ low-margins/large volumes/massive funding requirements/medium to long-term pay-back – are not features that typically attract smaller players into the industry. The ultra-high pricing environment of the past decade or so that encouraged smaller hopefuls into the sector is in no way typical. Prices leveled off and have since receded sharply as supply catches up with demand.

As a result, iron ore is predominantly the domain of mining heavyweights that can utilise their sizeable balance sheets to minimize exposure to potentially crippling debt levels and periods of price volatility.

The big miners however appear to have badly miscalculated in terms of future iron ore demand. As Richard Knights, a mining analyst at Liberum Capital Ltd told Bloomberg this week: “I’ve always taken the view that the miners had the best intelligence on this as large investment decisions are based on it. But if they get it wrong by a just a small margin, that has major implications for profitability and the share price for years to come.”

What he’s referring to are predictions by the Big Three that China’s demand for iron ore wouldn’t peak until around 2025 – 2030. However, Wolfgang Eder (Chairman of the World Steel Association and chief executive officer of Voestalpine AG, Austria’s biggest steelmaker) this week commented that China’s steel output would peak in as little as three years, prompting plant closures rather than expansions.

“There has to be a restructuring of the Chinese steel industry,” Eder said. “The iron-ore producers are getting more and more aware that their growth expectations have to be redefined. There are enormous over-capacities and more is coming on stream. This will increase the pressure,” he said.

To put things into perspective, every year for the past decade, China has added new mills with the capacity to exceed the annual production of Germany, the largest steelmaker in Europe.

But iron ore production has risen at an even faster rate, to the point where the market shifted to a point of structural surplus during the middle of this year. Citigroup forecasts that this surplus will widen to almost 300 million tons by 2017. Against such a background of excess supply, it is difficult to see a significant and sustained recovery in iron ore prices, particularly if Chinese demand is set to peak and residential construction growth continues to cool.

Fed action (or a lack of it)
For several years now there have been calls for Fed action on interest rates. For example during February 2012, President and CEO of the Federal Reserve Bank of St. Louis, James Bullard, argued “the Federal Reserve should start raising interest rates next year.” At the time he disagreed with the Fed’s decision during January 2012 to keep interest rates exceptionally low through to late 2014 to bolster the US economy.
As Bullard argued back in 2012, many years of near-zero rates risks causing “disaster.” Keeping rates low for several quarters is very different from keeping them there for years, which punishes savers.
Charles Schwab took the argument further, arguing back in 2012 that rock-bottom interest rates were destroying confidence in the economy and were unwisely forcing older savers to take risks with their money in search of decent investment returns. This greater risk-taking has manifested itself in the form of US share and property bubbles, incentivized by the zero-interest rate environment and the Fed’s easy money policies.
In the US, older savers’ and pensioners’ incomes have been squeezed by falling rates leaving them poorer. Savings rates have lagged behind inflation, reducing real incomes, eroding the real value of savings and lowering consumer confidence.
The Fed’s easy money policies have distorted market prices, encouraged destabilizing financial speculation, as well as unfairly punishing savers. But the far bigger concern lies in the future: the economy and financial markets have become so dependent on QE and artificially-suppressed interest rates that it will be very difficult for the Fed to reverse these policies without major repercussions.
The danger is that they won’t be reversed in time – resulting in a different (but equally serious) set of potential consequences. The Fed has a well established tendency to not recognize the effects of its loose monetary policy, nor to tighten, until it’s far too late.
On top of having many unintended negative consequences, ultra-low rates may also be ineffective in addressing the real economic issues. The continuation of low rates points to a worrying lack of growth and also highlights the increasing risk of deflation and a potential contraction in economic activity.
As Stanley Yeo, portfolio manager at IOOF commented recently, “Given that growth and inflation are among the primary requirements for a relatively painless reduction in elevated debt levels globally, the enthusiasm with low rates and quantitative easing among investors is curious.”
“The clear hope is that low rates will revive the economy. The theory predicts lowering rates will boost bank lending and increase access to credit for purchases of homes or other goods and services, ensuring economic recovery. However, the reality is quite different. In Australia, Reserve Bank research indicates that the savings from lower mortgage rates are simply being used to retire debt, rather than for consumption. While the reduction in debt levels is necessary, lowering rates will, of itself, do little to boost demand and economic activity,” he says.
Another problem that low rates might provoke is to tempt borrowers into ignoring their balance-sheet problems. The result could be that the problems are left to fester, making it difficult for central banks to raise interest rates to a more normal level in future years, for fear of the damage this might cause.
Banks might also become too optimistic about the ability of borrowers to repay, and fail to make adequate provisions for bad debts. When investments are made during a period of artificially low interest rates they are often ‘malinvestments’ as the low rates may send false signals to entrepreneurs and home buyers that the economy is good and investments/purchases should be made.
The term ‘malinvestment’ is a concept developed by the Austrian School of economic thought that refers to investments of firms being badly allocated due to what they assert to be an artificially low cost of credit and an unsustainable increase in money supply, often blamed on a central bank.
The unprecedented moves by central banks which were necessary to stabilise markets have had the desired effect of stabilising the financial system in the short-term. The big picture issue involves the unintended consequences of these ultra-low rates.
Large amounts of existing and borrowed capital have flowed into the stock and real estate markets chasing assets that are rising in price, not necessarily based on fundamentals but on the notion that they are rising and the potential returns are greater than low interest-bearing investments.

A golden opportunity?
Thisultimately brings us to gold. Yet again, sections of the media have been in a frenzy suggesting that gold has lost its safe haven status. The reactionary herd punished gold in the aftermath of the Fed’s September commentary, but the price is showing resilience.
Last year the gold price crashed once it became clear that the US Federal Reserve was looking to cut back on its Quantitative Easing (QE) program, on fears that it was QE that had been supporting the gold price. What had been forgotten was that the gold price had advanced strongly prior to the term QE even being coined, but the market – with its ultra short-term viewpoint – seemed to have assumed that QE and the gold price were inextricably linked, thus marking the yellow metal down.

This chart is fantastic because it demonstrates that despite perceptions of gold being an arcane relic, it has outperformed the Dow Jones Index since 2008 and the NASDAQ Index since 2005. In fact, only with the Dow at its current all-time high has it managed to recently surpass gold.
And to all the doubters that believe a rising US interest rate environment is bad for gold, in fact the opposite is true. The real driver of gold prices is negative real interest rates (defined by nominal interest rates minus inflation).
Central bank policies of inducing negative real rates to ‘incentivize’ borrowing, expand the money supply and devalue currencies – have forced investors (especially mums and dads) into real assets like gold and silver. Debt is inherently inflationary if you have the ability to print your own currency.
Gold of course rose along with interest rates during the 1970?s and this is sufficient to prove that gold doesn’t always fall when interest rates rise. The gold bull market of the 1970s was dominated by inflation – interest rates rose steadily to keep up with it, but real interest rates were mostly negative the entire time.
It’s possible to remain positive on gold and remain confident that the flow of gold from West to East will continue. China and India continue to be major buyers, but over recent times they have been joined by the Russian central bank. In fact the latest figures show that the country’s central bank purchased another 37.33 tonnes of gold during September, bringing its gold holdings to almost 1,150 tonnes – the seventh month in a row it has increased its gold reserves. It was also its biggest monthly increase overall.

Of course, many ordinary US investors like retirees and those saving for retirement, have been hugely disadvantaged by the Fed’s low interest rate policies since the GFC. The value of savings has been wiped out due to inflation, with investors forced to chase higher-risk opportunities in the sharemarket and the property sector. This has led to greater risk taking and led to speculative bubbles in both shares and property.

A good example is recent Bloomberg data that shows that only twice in the past 25 years have new apartment buildings in the U.S. been constructed as quickly as they are right now. And that’s not necessarily a good omen. The first occasion during February 2000 was right before the dot-com bubble burst. The second time, January 2006, came just before the housing bubble burst.

What’s interesting is that since the GFC, a lot of popular theories relating to the demise of gold have been proven false. A popular theory during 2009 was that a “green shoots” recovery would cause gold prices to collapse – but they didn’t. Then there was the popular “contrarian” argument that the real threat was deflation, and that gold would sell off as a result. But gold didn’t follow the script, rising instead of falling.

Now it’s the notion that rising interest rates will kill off gold.

One of the major reasons cited by commentators and financial experts for gold’s recent sell-off has been the prevailing view that interest rates will inevitably rise as economic growth builds. Central banks (the US Fed in particular) are also concerned about the long-term implications and economic distortions caused by a low interest rate environment.

There is a widely held view that a rising interest rate environment is negative for gold. While there may be a question mark over the robustness of the overall recovery scenario, let’s assume that interest rates will rise in line with perceptions of economic growth. Why shouldn’t gold benefit from a rising interest rate environment, just as it has done in a low interest rate environment since 2008?

Let’s examine the evidence of recent history. Significantly, gold rose with interest rates during the 1970s and this is sufficient to prove that gold doesn’t always fall when interest rates rise.

The real driver of gold prices is negative real interest rates (defined by nominal interest rates minus inflation). Central bank policies of inducing negative real rates to ‘incentivize’ borrowing, expand the money supply and devalue currencies, have forced investors (especially mums and dads) into real assets like gold and silver. Debt is inherently inflationary if you have the ability to print your own currency. As the chart below highlights, it’s happened before.

In a gold bull market that has been fueled by negative real rates, conventional thinking would suggest rate increases would, at the very least, halt the rise of gold as negative real rates get closer to turning positive. However, history actually says the opposite is true. The gold bull market of the 1970s was dominated by inflation. Interest rates rose steadily to keep up with it, but real interest rates were mostly negative the entire time.

Peaks in gold prices since 1975 have usually been associated with rising real interest rates. Occasions when real interest rates fell in tandem with gold prices include the period from 1987-1990 and from 1996-2001. Even though real rates have risen slightly, they remain below their historical average and levels below 2% have still been supportive of rising gold prices.

As the chart below from Goldman Sachs demonstrates, gold prices languished from 1980 to 2000 and had declining correlations with debt levels, because GDP growth was sufficient to suppress fears about budget and deficit issues. The current economic recovery has been too weak to support a sustained rise in real rates above the 2% level that has acted an inflection point for gold prices.

With energy and food inflation deepening and soon to affect consumer price indices, interest rates may have to rise significantly in order to restore real interest rates above 2%. This is exactly what ex-Federal Reserve Chairman Volcker did during the late 1970s, when he increased interest rates above 15% in order to protect the dollar and aggressively tackle inflation.

Despite the lower gold price (or perhaps because of it), central banks outside of Western Europe and North America are continuing to increase their gold holdings. According to the latest World Gold Council statistics, central banks have been buying gold at a higher rate than last year, with a reported 240 tonnes of purchases during H1 2014 compared to 180 tonnes during H1 2013.

The above chart highlights the strong relative performance of gold compared with both the Dow Jones and NASDAQ indices since 2000.

You could remain positive on gold if you remain confident that the flow of gold from West to East will continue. There is robust price support around the US$1,200 mark, a situation that may continue for the foreseeable future.

EIA officials have admitted that previous estimates of recoverable oil within the Monterey shale reserves in California of about 15.4 billion barrels were vastly overstated. The revised estimate has slashed this amount by an extraordinary 96% to just 600 million barrels of oil. The assessment cut US national reserves by 39%.

The Monterey formation, previously reported to contain more than double the amount of oil estimated within the Bakken shale in North Dakota, and five times larger than the Eagle Ford shale in South Texas, was slated to add up to 2.8 million jobs by 2020 and boost government tax revenues by $24.6 billion annually.

The main reason for the downgrade was that the original 2011 estimate mistakenly assumed that California’s shale oil and gas could be recovered with as much ease as it is elsewhere in the country.

However, the geology of the Monterey Shale is much more complex than in the Marcellus, Bakken, or Eagle Ford Shales – the three formations principally responsible for the surge in oil and gas production within the USA. The layers of shale in the Monterey are folded in such a way that drilling is difficult, and test wells thus far have come up disappointing.

The Los Angeles Times quoted a downbeat assessment from an official with the EIA. “From the information we’ve been able to gather, we’ve not seen evidence that oil extraction in this area is very productive using techniques like fracking,” said John Staub, a petroleum analyst with the EIA. “Our oil production estimates, combined with a dearth of knowledge about geological differences among the oil fields, led to erroneous predictions and estimates,” he added.

The oil and gas industry was quick to point out that the calculation could change once again if drillers could improve technology to access the Monterey. After all, no one saw the shale revolution coming only a few short years ago. But as Staub, the EIA analyst noted, for now oil and gas production in “the Monterey formation is stagnant.” And it could remain that way.

The sharply downgraded numbers come amid a heated debate within California at the present time over whether or not the state should permit oil and gas companies to use hydraulic fracturing (“fracking”) – the process in which a combination of water, chemicals and sand are injected underground at high pressure in order to break apart shale rock and access trapped natural gas.

Of course, issues over fracking are nothing new to industry participants, residents, landowners and activists on Australia’s east coast, where the ‘social licence’ of the industry to operate is an extremely hot topic of conversation and much debate at the present time.

The parallels between Australia’s east coast and America’s west coast are significant. Like NSW and Queensland, California is home to an enormous agricultural industry and with the Monterey Shale being situated beneath the fertile Central Valley, fracking is competing with agriculture, grazing and other commercial and residential users for water use.

On March 20, Santa Cruz became the first county in California to ban fracking. The move may have been symbolic though, since there isn’t much of a presence by the industry in that locality. It was aimed more at putting pressure on Governor Jerry Brown to stop fracking within the water-starved state. That follows a unanimous February vote by the city of Los Angeles to ban the practice, the largest city in the USA to do so.

But the issues with respect to California’s Monterey Shale are, in my opinion, even more significant from a broader industry perspective.

Just recently, the cover of Barrons magazine read “Here Comes $75 Oil”. The article argues that due to several new ‘game changers’ within the oil production industry, the oil price would fall to $75 a barrel within the next five years.

The three main reasons it argues that would contribute to cheaper oil are deep-water oil, shale oil and oil sands. All of these new-found resources are estimated at roughly 1 trillion barrels in newfound oil. When added onto the existing global oil reserve that’s currently estimated at 1.5 trillion barrels, this newfound oil is potentially a major factor in the future of oil pricing.

The article also references Citigroup energy analyst Eric Lee, who believes that most of this new oil could be recovered for around under $75 per barrel, leading to a global decrease in price.

The reality however does not marry up with such an optimistic outlook. After examining existing extraction cost data, it is hard for the supply-side economics to actually work out and support $75 oil for a sustained period of time. According to the EIA, worldwide consumption of petroleum products is forecast to grow by 1.2 million barrels per day during 2014 and 1.5 million barrels per day during 2015. This increased demand would put worldwide oil consumption at 91.60 million barrels per day during 2014 and 92.97 million barrels per day during 2015.

Last year, total world oil production came in at 90.33 million barrels per day, compared to a global consumption of 90.38 million barrels per day. The EIA would agree with the Barron’s article that new-found oil reserves will offset the current deficit, but current estimates show that newfound oil reserves would only add 1.3 million new barrels of oil to the existing world oil market.

This would put total supply estimates for 2014 and 2015 at 91.67 million barrels per day and 93.0 million barrels per day, a slight surplus, but not enough to justify a 25% decrease in price. The below graph highlights the EIA’s estimates for global oil supply and consumption over the past two years and its forecast for the next two years:

With respect to shale oil and gas, its method of extraction and production is difficult and costly. The primary reason for this is due to the fact that the oil is heavier and flows more slowly. This ultimately drives up the costs of production compared to more conventional oil extraction methods used by OPEC nations. Given the necessary time, difficulty, and cost, shale production break-evens within the US can range anywhere from $60 to $80 per barrel. At current oil price levels, there is room for healthy profits, but if prices were to contract, that healthy margin would evaporate, impacting production.

As oil price contraction becomes a possibility, several of the area’s largest producers – Continental Resources, Statoil, and Hess Corp – are all working to try and bring down the costs of production. Thus far, these firms have been successful at decreasing costs, but given the overall difficulty in extraction, those costs can only come down so far.

This should come as a signal that any significant downward change in the price of oil would be a major headwind for the continued operations of these firms, especially as they continue to push to increase output.

The EIA estimates that this year the U.S. will produce an average of 8.54 million barrels of oil per day. Compare this to the EIA’s estimate that the U.S. on average consumes 18.49 million barrels of oil per day. Even with the strongest domestic oil output since 1986, the US is still short by almost 10 million barrels per day of just meeting its own demand. When comparing total estimated US oil output during 2014 to the EIA estimates of global oil demand, US oil production in 2014 will only make up 9.32% of total global demand.

Some might argue that as more wells come online, US production will increase and make up a bigger piece of the pie. However, one of the biggest criticisms of standard shale wells is the short lifespan of the wells. Global Sustainability estimates that the US will need to drill 6,000 new wells per year at a cost of $35 billion just to maintain current production levels. Given this, the firm believes that by 2017 the US will hit its max production levels and ultimately return back to 2012 production levels.

Essentially, strong overall oil prices have encouraged the advent of shale energy and are continuing to facilitate its sustainability. Whilst shale can produce vast new volumes of oil, this comes at a cost – and relies on a strong underlying oil price for its sustainability. Shale can supply vast new oil supplies, but we must be aware of its limitations in terms of cost and other impacts.

What’s the outlook for the sector?
The outlook for the iron ore sector is extremely strong. Demand from the world’s two biggest emerging economies, China and India, is growing enormously. Both economies are seeing a construction boom, particularly with respect to residential construction, which means growing need for steel and hence iron ore.

Who are the major players?
Australian and Brazil are the two biggest exporters of iron ore. Brazil’s Vale is the biggest producer in the world, followed by Rio Tinto and BHP Billiton.

Are there any interesting smaller players?
The highest profile of the emerging players is Andrew Forrest’s Fortescue Metals Group, which is ‘the third force’ in iron ore in Australia.
There are also a number of newer, small-scale participants in Western Australia, South Australia and the Northern Territory. Some of these include Atlas Iron, Mt Gibson Iron Ore and Territory Resources, to name but a few.

What’s the chance of a glut in the next few years?
Given the strength in demand it is difficult to see a glut developing. Supply is still very much struggling to meet demand, so I don’t foresee any problems with oversupply on the horizon.

How does this sector relate to steel makers such as Bluescope and OneSteel?
Iron ore is a big factor with respect to both companies. OneSteel is interesting in that it mines its own iron ore, which it utilises in two ways – firstly it uses some for its steel production and the rest it sells offshore. So it generates income in two ways. OneSteel is effectively insulated from rising iron ore prices because it mines its own.
Bluescope on the other hand has to purchase iron ore and it currently buys it from BHP. Iron ore is a major cost input in steelmaking, so rising iron ore prices affect steelmakers like Bluescope.

OIL
The bigger picture as it relates to the oil sector remains simple: growing energy demand in emerging economies is set to put significant supply-side pressure on the world oil market over the next two decades. Of course to fully grasp this you need have to have an investment horizon that looks beyond the next few days or months.
What’s interesting is that oil prices have declined over recent months from a high in May of US$115 a barrel to a current low of under US$80 a barrel. Many investors are forgetting about the medium to longer-term picture and instead speculators and punters are driving prices and market opinion.
Oil prices in 2008 hit record levels of US$140 per barrel driven by surging emerging economy demand combined with supply-side fears; a situation exacerbated by speculators and ‘hot money’ flowing into the oil sector.
Because of this hot money, many dismissed oil’s significant rise as an aberration. As a result when the GFC hit, the price of crude oil fell back to below US$60 per barrel.
For a sizeable part of this year we’ve been pretty close to those former high prices, yet markets have been fairly complacent about these lofty price levels. There does seem to be a growing appreciation that higher oil prices of about the US$100 per barrel mark are becoming the norm rather than the exception. Furthermore, it will take a catastrophic meltdown and sustained stagnation in the world economy for prices to remain below US$100 per barrel.
Even afterthe GFC, which has devastated the economic landscape in two of the world’s biggest and most mature economies, the USA and the Eurozone, the price of crude has steadily climbed from its post-GFC lows because of burgeoning emerging–market demand, particularly from China. In the future, India will also play a greater role.
The oil industry is facing a tough challenge as it tries to generate enough production to meet growing demand. The industry reality is that it takes five to 10 years from discovery to first oil production, a long time when typically the size of the average field is getting significantly smaller, is more inaccessible and much more costly to develop.
The world effectively stopped finding large oil fields about 40 years ago. The production from the remaining large fields is falling every year and the industry simply cannot bring enough smaller fields on line fast enough to meet those declines and increase daily oil production.
The demand side of the equation isn’t providing any comfort either. While oil demand will be somewhat softer over the next six months because of international economic circumstances, the world’s population keeps growing each and every year.
If you consider how the populations of China and India (as well as other emerging countries) and how relatively little oil they currently use, it’s easy to see that changes in their lifestyle will inevitably involve more oil consumption, which will make a huge difference to the world’s oil demand-supply balance.

GOLD

Apparently the gold bubble has burst – the weakening value of gold over the recent weeks in particular has led to many negative comments about the metal’s future. Like the oil sector, you have to take a step back and put gold’s price fall into its proper perspective.
Gold is 10.5% weaker (or US$192.70 in price terms) than it was a month ago, but by the same token the metal is still 26% higher (or US$339.40 in price terms) than it was 12 months ago, even accounting for the latest price correction. This is hardly a matter of the gold bubble bursting.
What we are seeing is a price correction that is healthy for the market – there was a similar correction in the latter part of 2008.
These types of corrections are normal and not unexpected. Since the start of the quarter, gold bullion had rallied by more than 25% to its recent record high of US$1920 on the back of investor nervousness. At US$1600 gold has merely reverted back to its trend-line.
One of the major anomalies of gold’s strong price run since late 2008 has been the corresponding underperformance of gold equities. During the immediate sell-off after the GFC, gold (like everything else) was hit hard, but gold equities were hit even harder. And gold equities have maintained their relative underperformance since late 2008 until now. In fact, the performance divergence is once again growing.
What this means is that investors have remained somewhat nervous about equities of all types since 2008. While gold equities should naturally benefit from the strong underlying performance of gold, investors have remained nervous about share market exposure. Hence, they’ve opted for the relative safety of physical gold rather than investing in gold stocks.
The important thing that investors have to understand about the recent gold price correction and the correction in late 2008 is that gold has been sold off because it has been a profitable asset. It has effectively been used as a source of funding for margin calls made on declining assets in investors’ portfolios, such as equities. This means gold is effectively undergoing forced selling.
Many inexperienced investors and market-watchers have an unrealistic expectation of how gold performs during a crisis. Gold, like everything else, gets sold down during the midst of a crisis as desperate investors attempt to raise cash. During the GFC this amounted to a 25% price fall for gold, from which the metal both strongly and rapidly recovered.
This time around it’s been a fall from a high of US$1,920 to a low of US$1,531 in late September (a fall of 20%), but the price has already rallied 8% (or US$114 in price terms) from that low. Again, you have to stand back and judge gold’s performance over a period that’s much more representative than merely just a few days.
When you do this, a la 2008, you do get an appreciation that gold indeed does retain and deserve its safe-haven status.
Over the next few months it is likely that the US Dollar will retain its strength and that the price of gold will underperform for the time being, in a scenario similar to that post-GFC. This provides a period of consolidation for gold and a buying opportunity for investors, before the next upward leg in gold’s price climb (US$1,600 in my view is the critical gold buying level for investors).
Market disenchantment with the US Federal Reserve’s Operation Twist and the likely clambering in some quarters for some form of additional fiscal stimulus (potentially QE3) to help resuscitate the ailing US economy, are all factors that are likely to kick-start the next phase of gold bullion’s price ascent.