Is the Worst Finally Over for Gold?

Wall St. Cheat Sheet

The recent price movement of gold has been extremely bearish. Despite logging twelve consecutive annual gains, the precious metal is one of the worst performing assets this year. However, with sentiment at rock-bottom levels, the worst may finally be over.

Over the course of only two days in April, gold plunged $200 to reach its lowest level since February 2011. In the process, gold posted its worst one-day percentage drop since 1980, and the largest fall in dollar terms on record. On a technical basis, gold reached its most oversold reading since at least 1975. The dismal performance was followed with a 5.4 percent loss in May. In fact, gold has now declined for seven of the past eight months.

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Last month, several well-known firms lowered their price targets for gold. Credit Suisse Group believes the precious metal will trade at $1,100 an ounce within a year, and below $1,000 in five years. Ric Deverell, head of commodities research at the bank even said, “Gold is going to get crushed.” Meanwhile, JPMorgan Chase (NYSE:JPM) cut its outlook for gold in 2013 to $1,595 an ounce, compared to its previous forecast of $1,745. The bank’s 2015 forecast was reduced 5 percent to $1,650 an ounce.

Some investors have become discouraged with gold’s performance, but demand is not as bearish as one might think. In the first quarter of 2013, total gold demand reached 963 tonnes, representing a 13 percent drop from a year earlier, according to the latest report from the World Gold Council.

Heavy selling pressure and outflows from exchange-traded funds accounted for the majority of the decline, but strong demand was seen in gold jewelry, bars, and coin. Total jewelry demand jumped 12 percent year-over-year to 551 tonnes in the first quarter, easily topping the five-year average of 500.5 tonnes. Meanwhile, total bar and coin demand increased 10 percent to 377.7 tonnes, compared to a five-year average of 281.3 tonnes.

With the major central banks around the globe still practicing easy-money policies, other central banks are loading up on assets that cannot be printed. In the first quarter, total central bank demand reached 109.2 tonnes, 5 percent lower than a year earlier, but still the ninth consecutive quarter of net purchases. Over the past four quarters, central bank demand has jumped 21 percent.

“The steady level of buying confirmed that central banks and institutions continue to favor gold’s diversification benefits, as they reduce their portfolio allocations to U.S. dollars and euro,” the WGC states. Again during the first quarter, the central banks adding to their gold reserves were distributed widely around the globe, with volumes concentrated in emerging markets.”

Nothing goes straight up or down forever. With gold finding support at $1,325 an ounce, some firms are starting to take the other side of the great gold debate. Stern Agee believes buyers in China, India, and the Middle East will continue to buy the dips and support gold prices in the long-term. Analyst Tom Fitzpatrick from Citigroup recently noted that gold hit as low as $682 in October 2008, but rallied to $1,921 within three years. A similar move today could send gold to $3,500 by 2016.

The Market Vectors Gold Miners Index ETF and its junior counterpart are both down more than 30 percent this year, but miners are starting to look interesting at current prices.

Farooq Hamed from Barclays notes, “With the significant YTD sell-off in the gold equities, we believe that gold company valuations have become very compelling when compared against historical trading ranges and versus stocks in other resource sectors. Combined with attractive valuations, we believe gold companies are showing early signs of performance improvement, specifically free cash flow generation improvement, by way of new cost and capital reduction programs announced in 2013. Coupling attractive valuations with signs of performance improvement, we believe gold equities could be reaching an inflection point.”

Although gold prices certainly experience high volatility at times, the precious metal can still play an important role in a portfolio. It is unreasonable to expect gold to climb higher every year, but it is also unreasonable to expect it to decline and become completely irrelevant with the current status of the global financial system.

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