The end of Federal Reserve emergency cash is unlikely to derail gold’s 10-year rally, but the precious metal might face a rockier road as the cheap money that had fuelled its ascent dries up, at least for now.
Fund managers have cited the threat of deflation, slower growth, a resurgent dollar and gold’s overvaluation as just a few reasons why the precious metal’s performance as a safe haven is unclear. In the past, its value tended to rise in times of economic crisis.
Since the global economic downturn, however, gold has benefited from a string of stimulus measures by central banks attempting to boost growth.
Gold prices have doubled since the 2008 crisis, but that rally may be difficult to sustain if the Fed winds down its cheap money policy. Kacper Pempel / Reuters
Bullion has more than doubled from its 2008 low at the depth of economic crisis, and is up 20% since Federal Reserve Chairman Ben Bernanke’s Jackson Hole speech last August, which marked the start of the Fed’s second round of quantitative easing.
On Thursday, the Federal Reserve ended its $600 billion bond-buying program known as QE2, for quantitative easing, because the addition of money to the monetary system effectively lowered US interest rates.
“Even with the QE ending, there is no prospect of the Fed increasing rates any time soon. We have negative US real interest rates. And gold historically did very well in a negative-real-rate environment,” said Bob Haber, chief investment officer of Haber Trilix, which manages $2 billion in assets and runs US and Canadian hedge funds.
On Friday, Gold fell below $1,480 an ounce, nearly $100 below its record high of $1,575.79 set on May 2.
Fed Chief Bernanke has yet to offer any hints of further monetary easing, or QE3. Even though the Fed is not expected to tighten money policy any time soon, gold is likely to rally if the US central bank reintroduces additional market stimulus, which US President Barack Obama called for this week to spur job growth.
“The notion of QE3 is more liquidity, which will likely be dollar-unfriendly. And it would then further run the risk of inflation,” said Mark Luschini, chief investment strategist at broker-dealer Janney Montgomery Scott.
“With that being taken off the table at least for now, it was enough to obviously impair gold prices heavily,” he said. Janney manages $54 billion in assets.
Dollar as reserve currency
A strong US dollar undermines gold’s status is as an alternative currency.
Most commodities, including oil and gold, are denominated in the greenback, which remains the world’s reserve currency, despite an uncertain US economic outlook and political tensions about raising the debt limit in the world’s largest economy.
Most investors see dollar strength limiting gold’s gains.
“If risk assets sell off, and people shun the dollar, that’s when we are in a new regime, that’s when gold’s going to take off. But, I don’t see that happening,” Jeffrey Sherman, commodities portfolio manager of DoubleLine Capital, which oversees $12.5 billion in assets.
Sherman said the threat of deflation, partly created by a European debt crisis, should drive investors toward US Treasuries and the dollar, making gold susceptible to weakness.
“Gold is somewhat of a safe haven, but it’s only a safe haven when you are worried about inflationary pressures,” he said.
Billionaire financier George Soros dumped almost his entire $800 million stake in bullion in the first quarter. Famed gold bull John Paulson remained the largest holder of the SPDR Gold Trust at the end of the first quarter.
Overvaluation?
The precious metal, which notched 10 consecutive yearly gains, has increased fivefold from just $250 an ounce in 2001. Adjusted for inflation, bullion’s all-time high was above $2,200 an ounce set in 1980.
Gold’s rally appeared to stall at the end of the second quarter, but the metal still posted a 4% gain in a quarter that saw the benchmark index of 19 commodities fall 6%.
Jason Pride, director of investment strategy at Glenmede, a wealth management firm with $20 billion in assets, said the extreme valuation of gold is hampering its ability to rise further and perform as a safe haven.
“It has simply gotten to a point now where the value of gold puts investors looking to protect their portfolios at risk simply from the valuation angle,” he said.
Bullion should still offer some protection against inflation and sovereign debt default risk due to its unique role as a global monetary vehicle, but its overvaluation is likely to constantly drag down on prices, Pride said.
“With gold having no dividend, no profit, it’s as much a visual reaction to what you think is going to be the direction of gold as anything, because there is really nothing you can point to from a fundamental standpoint that says it should be worth X or Y,” said Janney’s Luschini.
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