Gold: Haven turns riskier but retains its appeal

Bewitched, bothered and bewildered – that is how many gold bulls have felt in recent months. As the eurozone crisis has ratcheted up to fever pitch, their beloved precious metal – supposedly a haven against precisely this sort of financial market turmoil – has barely budged in price.

Since mid-October, gold has traded in an uninspiring range of roughly $1,650-$1,750 a troy ounce.

More worryingly for its supporters, the metal appears to be moving more closely in line with risky assets such as equities and emerging-market currencies than other havens such as US Treasuries.

“There has been a lot of disappointment with gold in the fourth quarter, especially from those who were banking on the metal’s safe haven properties, given the escalating situation in Europe,” says Edel Tully, precious metals strategist at UBS, the Swiss bank, in London.

The problems began in September. After hitting a record of $1,920 early in the month, gold collapsed 20 per cent in a matter of days. It was the metal’s sharpest weekly fall since 1983.

The plunge came amid a broader market sell-off, surprising some investors who had assumed that holding gold could act as a form of insurance against bullish positions in other commodities or equities.

The reason for the sharp fall was simple: as investors were rapidly losing money on other positions, they sold their gold to raise cash.

However, it caused investors to question gold’s claim to be a “safe-haven” asset. The metal’s case has not been helped in the months since, when gold has tended to rise as risk appetite rises, and fall when risk appetite wanes.

The dominant theme has been a “dash for cash”.

Most prominent among the investors forced to sell was John Paulson, the hedge fund manager who shot to prominence with an enormously profitable bet against the subprime mortgage market during the financial crisis.

Over the third quarter, Mr Paulson’s fund sold more than a third of its holdings of the SPDR Gold Shares exchange traded fund, equivalent to about 34 tonnes.

Elsewhere, European banks have been using their gold holdings to raise cash amid a widespread shortage of dollars in the region.

Dealers say that banks – primarily in continental Europe – have been actively lending gold in the market in exchange for dollars. The move has pushed gold lease rates – the implied interest rate for lending gold in the market in exchange for dollars – to record lows.

The one-month gold lease rate in December hit -0.57 per cent, suggesting that a bank lending gold for one month would have to pay to do so, at an annualised rate of 0.57 per cent.

“Gold is a function of liquidity,” says Walter de Wet, head of commodities research at Standard Bank. “Certainly there has been a lack of liquidity, particularly in the interbank market in Europe. That is putting a drag on gold.”

But while investors are feeling bruised, few are ready to call time on bullion’s decade-long rally.

“Commodity hedge funds are still involved in trading gold. It is still a popular trade,” says Fabio Cortes, manager of a commodities fund of funds for Oakley Capital, the private equity firm in London. Of the metal’s safe haven appeal, he adds: “It hasn’t lost it – it has been reduced to some extent.”

Indeed, the fundamental drivers of the surge remain in place. Central banks are buying record quantities of the metal. The so-called “official sector” bought 364 tonnes of gold in the first three quarters of this year, according to data from Thomson Reuters GFMS, the precious metals consultancy, compared with sales of more than 400 tonnes a year in the decade to 2009.

Moreover, Chinese demand is increasing rapidly as Beijing deregulates the country’s gold market.

Chinese imports of gold from Hong Kong have hit record levels in recent months, and the country is on track to more than double imports from last year.

Matthew Turner, precious metals strategist at Mitsubishi, the Japanese trading house, argues that the crucial determinant of whether gold lives up to its safe-haven billing is whether investors fear inflation.

“At different times investors seek different safe havens. During equity market crashes, investors tend to seek safety in the dollar, or bonds, and only sometimes gold,” he says. “Other financial panics might involve investors selling government bonds or fleeing the dollar due to rising fears of inflation. In these scenarios, gold can outperform.”

This suggests the trigger for gold’s next move is likely to be the actions of central banks – particularly the European Central Bank, which many investors believe will be forced to provide a backstop to the eurozone by more aggressively intervening in the sovereign bond markets.

In the second quarter of 2010 and the third quarter of this year – the two moments when the ECB moved to expand its bond-buying activities – gold demand jumped.

For next year, the ECB is likely to be the key to gold’s performance.

As Ms Tully predicts, if the ECB were to embark on a policy of quantitative easing, it would have “explosive implications for gold”.

Source: http://www.ft.com/intl/cms/s/0/6e68b5e2-24d9-11e1-8bf9-00144feabdc0.html#axzz1i2iwpKa6