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Has gold entered a bear market?
April 26, 2013

With the price of gold plunging suddenly, that is the question on everyone's mind. But is it just a correction in the ongoing bull run? Here are various opinions on the subject...


Author : Content Team



 Has gold entered a bear market?

When everyone was stunned at the dramatic drop in the price of gold, Goldman Sachs was not. CNBC reported that two weeks prior to the metal taking the elevator down, the firm's commodities research team gave a call to short gold. Though the analysts too admitted that the decline on April 15, 2013, was rapid and greater than expected.

Back on April 10, when gold was ranging in the upper-$1,500/ounce, Goldman recommended shorting the metal on the grounds that gold didn't move up significantly when markets were anxious about the bailout of Cyprus and restructuring of its banks.
Within days of that call, gold fell almost 16% to $1,321/ounce. While the bailout of Cyprus did not send gold higher, reports that Cyprus would sell gold to cover its shortfall sent the metal tumbling, as traders bet other European countries might also sell gold to raise cash.

The fall in the precious metal made everyone wonder if we have entered a gold bear market.

Ted Scott, Director – Global Strategy, F&C Asset Management noted that the dramatic fall in the price of gold on April 15, 2013, was the biggest since 1983. His view was that the recent sell-off is the biggest since gold started its ascent and with a fall of over 20% since it peaked, gold has been officially declared to be in a bear market. Yet, he goes on to argue that investors must decide whether the change is for fundamental reasons or if it represents a temporary setback. He then goes on to cast his bet with the latter view and believes that the reasons for the dramatic fall in the gold price is largely tactical and technical. He does not think that it undermines the long term and strategic case for holding gold as an essential component of a diversified investment portfolio.

Financial Times reports on other portfolio managers who are of the same view.

David Rosenberg, Chief Economist & Strategist, Gluskin Sheff, believes it is a correction in a bull market. He adds that anyone who predicted 10 years ago that the gold price would be trading in a bear market in 2013 after a correction of more than 20% at around $1,400 an ounce “would have been carried out in a straitjacket”.

Richard Davis, Portfolio Manager – Natural Resources Equity Team, BlackRock, does not see this sell-off as the start of a bear market for gold. According to him, the sell-off in gold mining stocks has been indiscriminate, presenting “some excellent buying opportunities for the longer term”.

Joe Foster, Portfolio Manager, Lombard Odier World Gold Expertise Fund, says the fundamentals for gold as a haven have not changed and the gold market has experienced a “mid-cycle correction” which “could represent the buying opportunity of a lifetime” once prices stabilise.

Below is an extract from an outlook report on gold by Reliance Mutual Fund.

Top 10 gold purchasers


Country

Q4 2012 holding (tonnes)

Purchases in the last 10 years (tonnes)

China

1054

553

Russia

958

531

BIS

520

323

Turkey

360

244

India

558

200

Saudi Arabia

323

180

Mexico

125

118

Thailand

152

75

Korea

84

71

Argentina

62

61

  • Gold purchases by people in India and China are soaring. These two countries contribute to 52% of the total gold demand right now, vs. just 25% a few years ago.
  • Central banks are on a buying spree. In the last year, central banks have bought the highest quantity of gold over the past 48 years.
  • Central banks bought more than 145 tonnes in the fourth quarter of 2012. Central bank buying for 2012 rose by 17% over 2011 to sum 534.6 tonnes.

Gold as a percentage of total reserves


Country

Q1 2002 (%)

Q4 2012 (%)

United States

58.30

75.70

Italy

50.20

72.10

France

49.60

70.50

The Netherlands

47.20

59.70

Germany

39.10

72.80

Russia

11.10

9.50

Sweden

11.00

12.80

United Kingdom

8.30

15.70

Kuwait

7.00

12.70

India

6.30

9.90

Turkey

5.20

16.10

Cyprus

4.80

62.20

China

2.10

1.70

  • Gold is only 13% of the reserves of the world.
  • China and Russia, which have been the largest purchasers of gold in the last decade, have only 1.7% and 9.5% of gold as a percentage to their Treasuries, respectively.

What if 3 countries want to increase gold as a percentage of total reserves?


Country

Gold as a percentage of total reserves (%)

Additional requirement (tonnes)

China

5

3,000

 

10

6,000

India

20

500

 

25

625

Russia

20

900

 

25

1,125

  • Gold production per year is expected to be around 2,800 tonnes per year which will barely fulfill the demand of central banks and individual consumers.
  • If Asian central banks increase their gold reserves to 15% they would require more than 15,000 tonnes of gold. This will lead to a spike in demand for gold as the annual production is only 2,800 tonnes.
  • Demand supply dynamics hints towards higher gold prices. Demand will likely continue to move higher but no major additional supply is expected over the foreseeable future. Central bankers used to sell around 400-500 tons, now they buy around 400-500 tons. This swing of around 800-900 tons is a major factor because the new gold supply per annum is only around 2,650 to 2,850 tonnes.

The report concludes by stating that one of the tenets of portfolio theory is that over the long run a well-balanced asset allocation increases a portfolio’s risk-adjusted returns. Hence one should allocate an appropriate allocation among different asset classes.
Historically, gold can be considered as a good diversification tool. Gold prices have corrected significantly and it seems to be an ideal time to invest in gold.

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