A perfect storm for the gold price

The gold price has suffered one of its sharpest declines in years, says Andrew Critchlow in The Daily Telegraph. It sank by almost 6% last week to a four-year low below $1,170 an ounce. The yellow metal faces “a perfect storm”, says Capital Economics.

Demand for a safe haven has fallen for several reasons, notably strong US growth. GDP expanded by a stronger-than-expected 3.5% in the third quarter and a weekly tally of claims for unemployment benefits slipped to a 14-year low.

There has been no sign of inflation yet either. A good GDP figure “without strong inflationary bias is a clear negative for gold”, says HSBC.

Strong growth raises the prospect of higher interest rates in the not-too-distant future, and as gold pays no interest it always suffers if other assets look set to yield more.

Last week, the US Federal Reserve ended its quantitative-easing (QE) programme and indicated that an improving labour market implied higher interest rates next year. Its unexpectedly hawkish tone reinforced the notion that higher rates will arrive sooner rather than later.

This also fuelled the rally in the US dollar, which has reached a four-year high when measured against a basket of major trading partners’ currencies. When the dollar appreciates, commodities priced in dollars weaken, as it takes fewer dollars to buy them.

So it’s no wonder investors are fleeing gold. Global holdings in exchange-traded products backed by the metal have dropped to their lowest level in five years. Usually, when investors rush for the exits, bargain hunters in the physical gold market – jewellery and bars – make up some of the lost ground.

China and India are two key sources of physical demand, but while demand from these sources has ticked up, it is unlikely to surge as there are currently “no gold-related festivals or holidays lurking”, says Edel Tully of UBS – unlike four weeks ago, for instance, when India was preparing for Diwali.

Despite all this, however, we continue to recommend holding 5%-10% of your portfolio in gold. Consider it insurance against a possible surge in inflation over the next few years.

There is clearly scope for turbulence as a debt-soaked world economy and overpriced markets come to grips with dearer money.

Investors could well come once again to appreciate an asset that, as MoneyWeek’s Tim Price puts it, offers “independence, scarcity, and permanence”.

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