We recently asked Daily Pfennig® readers to weigh in on their personal expectations for the price of gold by the end of 2013. Readers were given a range of outcomes from which to select, spanning from below $1,000 per ounce to more than $1,900 per ounce by year-end. The distribution of answers, shown below, shows a strong skew toward gold prices at year-end being higher than the current $1,358 per ounce level as of May 20.
In fact, 84% of respondents indicated that they believed the price of gold would be greater than $1,300 per ounce by year-end, with the largest distribution expecting the price of gold to be between $1,601 and $1,900 at the end of the year, or between 18% and 41% more than the current $1,357 price level.1 Conversely, only 16% of Pfennig readers expect the price of gold to fall below $1,300 per ounce over the next seven months of the year.
It should not be surprising that Daily Pfennig readers’ results are skewed toward the upside in terms of price expectations for gold, especially considering that most of them are inured to view gold as a potential hedge against U.S. dollar exposure, and by extension, the outlook for U.S. economic stability. From this perspective, the analysis of monetary fundamentals has not changed materially since gold prices reached a peak of $1,900 per ounce in September 2011, shortly after the first ever downgrade of U.S. sovereign debt by Standard and Poor’s.2 On the contrary, many could argue that monetary fundamentals have deteriorated since September 2011 based on increased debt levels, continued deficit spending, and an acceleration of Federal Reserve bond purchases, known as quantitative easing.
Longer-Term Confidence in Gold Overwhelmed by Short-Term Trading Pressures
Despite this backdrop, gold spot prices have fallen nearly 30% since the peak in September 2011, dropping 19% since the beginning of 2013. Furthermore, bearish sentiment for gold by money management firms and traders continues to increase with selling pressure, as shown in weekly Commitment of Traders reports from the U.S. Commodity Futures Trading Commission (CFTC) indicating short gold futures-and-options positions reaching notable highs.
This apparent disconnect between monetary fundamentals and current pricing sentiment for gold may be explained by the difference between short-term and longer-term objectives for investors.
Analyzing the flow of recent market intelligence, short-term traders can make a reasonable argument for the drop in gold prices. On the margin, reported U.S. economic fundamentals appear to be improving with housing markets stabilizing, unemployment levels dropping, and confidence returning to U.S. markets. Recent comments from regional Federal Open Market Committee (FOMC) members insinuating a slowing in Fed bond purchases only help to support this trend. Certainly, strength in U.S. equity markets has attracted a great deal of global attention from investors. The resurfacing of U.S. confidence has been reflected in the recent strength of the U.S. dollar, placing even more price pressure on commodity markets priced in U.S. dollars. With higher U.S. equity markets and commodity prices lower, U.S. consumption may be poised to increase and help to advance U.S. Gross Domestic Product (GDP) growth. Not surprisingly, bullish trading in gold does not fit well into this market narrative.
However, short-term complacency in markets often provides longer-term investors with opportunities to acquire forms of insurance at lower prices. Readers who have considered buying out options for portfolios immediately after a market sell-off are well aware of the increased cost of this protection. Similarly, the time to purchase homeowner’s insurance is not after the flood or hurricane, but when expectations for these potential events are low. It therefore stands to reason that as near-term prospects for a catastrophic market event begin to fade, the price for instruments that help to hedge against breakdowns in the dollar or market would become less expensive as a result. This, in all likelihood, does not mean the nature of these events should be considered off the table.
In this light, market participants with short-term negative views on gold pricing are not necessarily being irrational by selling positions, while longer-term investors can appropriately add to positions at lower prices to dollar-cost average to enhance strategic positioning.
What Kind Of Gold Investor Are You?
Purchasers of gold at this point in time should strongly consider what type of investor they intend to be, as well as evaluate the objectives of holding gold in terms of a broader wealth strategy. Investors looking to trade gold on a short-term basis, both long and short exposure, should be aware that while the trend in gold remains downward, a short-covering rebound—given the level of short interest in the futures market—could be abrupt. Conversely, continued strength in the U.S. dollar and marginal improvements in the U.S. economic outlook could very well maintain a selling bias. Ask two different market strategists which way to invest, and you will likely get three separate answers.
Investors looking to gold as a longer-term investment or as part of a broader wealth management strategy should consider the original premise for holding gold. The longer-term purpose of allocations to gold as part of a portfolio strategy may include protection against a weaker dollar, purchasing power security, hedging U.S. dollar investments, hard currency exposure, store of value, or as a diversification asset, just to name a handful.
Arguably, the more pressing questions for investors looking to add to current positions relate to timing and amount of exposure. Unfortunately, these answers are not found in investment strategy textbooks, but rather come down to personal risk tolerance, investment horizon, and return objectives. Nevertheless, perhaps an old saying that Wall Street analysts like to apply may be appropriate for some inspiration: “If you liked it at $1,600 an ounce, you’ll love it at $1,300 an ounce!”