One of the hot investment phrases streaming through the investment media lately is “currency wars.” This refers to the idea that governments around the globe are fostering weak currency policies in order to export their way to prosperity at a time when world aggregate demand is weak. Japan is the latest country to weaken its currency, as new leadership has recently diluted the value of the Yen materially in an attempt to jumpstart their way out of deflation. So with all these countries racing their currencies to the bottom, shouldn’t gold be the store of value that we can all depend on? One look at the chart below tells you that gold has not received the memo.
Gold is supposed to act as an alternative currency in times of monetary debauchery, guarding against the inflation that might emerge in the wake of this grand monetary experiment. Above all, gold is supposed to be a safe haven in an unstable world… So how can it be dropping now?
We don’t have a clear answer, nor can we guarantee that it’s not just marking time before it explodes to the upside and rejuvenates the spirits of the gold bugs. But we do have some observations about the metal as an asset class, along with some reasons for why we sold our gold position in early January.
The fact is, gold is a tough sale if you’re looking for a cheap asset class. One glance at the annualized return of gold tells me that this is not a bull market in its infancy. Gold has generated annualized returns of over 16% since 2000, and managed to outpace emerging stocks, small capitalization stocks, the S&P 500, aggregate commodities, European stocks, and aggregate bond indices. Its supporters would argue that the best is yet to come, but I tend to think the asset has enjoyed its best days for the foreseeable future.
Another point to remember is that gold peaked in parabolic fashion as it soared over 1900 in the fall of 2011. I hesitate to call an asset classes a bubble, since the m
edia is very quick to falsely label any asset that has moved a material amount as a bubble. But in gold’s case, I think the name may fit. Gold has a story the world got wrapped up in, its bull market matured in a world of hyper central bank activity, and it is easily traded by the masses given the advent of ETFs. Some of the sharper independent analysts we read have shown that a gripping story, lots of liquidity, and a vehicle for the masses are some of the classic elements of assets manias or bubbles.
Finally, for the past few years investors have lived in fear of the next shoe to drop. First there was Lehman, then problems in Europe stoked fear of banking system crashes and systemic risk. This post Lehman age has helped drive investors into the so-called ‘safe haven’ trades of bonds and gold. Ironically for gold advocates, system risk has been fading since late 2011, and we may be getting close to the point where greed returns and safe havens get liquidated from portfolios in exchange for risk assets that have been performing. If equity risk premiums drop, it is very possible that gold could be replaced with the next risk asset du jour.
With all of that said, in the short term sentiment is contrarily pessimistic and gold could be due for a reflexive bounce at any second. More important than that, many traders will be watching whether it holds or breaks down through the 1525 level on the price chart. If it holds, some investors might conclude that the bull market is still intact and good value has been created. But if it doesn’t, you might be looking at an asset class that is exiting a bubble phase with poor fundamentals and terrible technical underpinnings.
If gold can’t hold the 1525 line, traders will be yelling to “look out below!”
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