Analysis: Gold rally stumbles

Gold’s first peek at the magic price of $US2000 an ounce ended in disarray last night, a reminder to all investors that bubbles deflate faster than they inflate.

That is not to say that gold will not eventually crash through the $US2000/oz barrier, but there are warning bells ringing that signal the potential for a major price correction.

The problem is not that gold will suddenly become less attractive relative to other investments. It is more a case of gold becoming a plaything of speculators rather than an object for serious investors.

Gold is in danger of being loved to death.

Last night’s $US76/oz slide from a record $US1910/oz to around $US1834/oz was a warning from an over-heated market.

Arguments in favour of owning some gold are easy to identify and include the facts that: 

• Most of the world’s central banks keep some gold in their reserves, and are continuing to buy it.

• Gold has resumed its role as a currency beyond the control of governments.

• The European debt crisis is far from over, and the U.S. is verging on a state of technical bankruptcy, but can fix that overnight by taking the easy option and printing more money.

The rush into gold this year, from a start in January at $US1388/oz to this week’s peak of $US1910/oz means that at its high point the gold price had risen by 37.6% in eight months, or close to 5% a month.

No asset can maintain that pace without eventually running out of steam and crashing back to earth. The only unknown is when, and while that is impossible to predict consider some of the evidence pointing to gold entering the final stages of this year’s remarkable rally.

In New York, the world’s biggest exchange-trade fund (ETF) specialising in gold, SPDR Gold Shares, sailed past the previous biggest fund which tracks the stock market, the SPDR S&P 500 ETF (known as SPY).

Once you separate that alphabet soup of names what you see is that American investors have been piling into gold funds, with $US1.2 billion invested in SPDR Gold Shares on Monday alone, taking the total held in that fund to $US77.5 billion compared with $US74.4 billion in the SPY fund.

A similar pattern is evident in Europe, though over there it encompasses all commodities with funds deposited in commodity-based ETFs exceeding funds in fixed income ETFs for the first time.

Listed commodity funds in Europe now hold 42.8 billion euros compared with 41.4 billion euros in fixed interest funds.

The problem with this scramble to snatch some exposure to gold is that too many people are making the dash too late, and most of them are doing it for the wrong reason. They simply see gold as a place to make a quick profit, or as a safe haven while financial storms are blowing – before moving on to the next fad.

There are three other items of evidence to make the case for the gold price being overheated. They are:

• The share price of most goldmining companies not keeping pace with the price of the metal, a sign that investors in equities do not believe that the sky-high gold price can be sustained.

• Gold price tipping has gone into overdrive with major newspapers in the U.S. and Europe which traditionally criticize gold joining the gold cheer squad.

• Comparisons being made with earlier asset bubbles as a reason to see gold hitting $US3000/oz.

Perhaps gold will get that high. One of the world’s more serious newspapers, The Wall Street Journal, yesterday graphed the gold price alongside the tech-bubble of the late 1990s, and the bubble in U.S. home building stocks before the sub-prime crisis of 2007. The parallel is eerie.

According to the WSJ analysis gold is about half-way up the rocket run seen in tech and building stocks – which is why the newspaper headed its analysis: “Gold $3000?”

The problem is that the rush to $US3000 will only be surpassed in speed by the fall on the other side of the graph, as it was with tech and building stocks.

If you do not already own gold as part of your investment portfolio then beware today’s price. It is inflated, possibly for some right reasons, but the risk of a major correction grows by the day.