Gold’s glow still strong

This week’s big fall in the gold price was a reminder to investors that what goes up inevitably comes down but was the fall really a signal the world has become a less risky place?

The short answer to that question is no.

The long answer is contained in the latest Global Financial Stability report from the International Monetary Fund, which contains a stark warning about the potential for a re-run of the 2008 financial crisis, and worse.

Before considering both issues, the price of gold and the IMF warning, it is interesting to look at the timing factor, with the gold price plunge preceding the IMF report by just three days.

In terms of a disconnection between how investors see the financial climate and how one of the world’s leading economic agencies is reading the same data, the sight of gold going one way and the IMF seeing things possibly going the other is one of the more curious events of the past five years.

As well as being a wake-up call that all is not well with the world, the IMF report was a remarkably strong buy signal for gold, which was made stronger by the price plunge which blew much of the froth off the gold market, bringing the metal back to a more attractive price.

There are several reasons why gold remains an important part of any investment portfolio, though it is important to separate gold in its purest metallic form from gold exploration or production companies, where the effects of last week’s price fall are not yet known.

In some cases, the price plunge might have triggered banking covenants or exposed ill-conceived hedging and forward-selling programs, a long-winded way of saying that a major movement in any market can cause significant losses, which are yet to be revealed.

What drove gold down last week was a combination of factors that included fear of heavy European selling (private and government) as that region’s economy slides deeper into recession, and a theory being marketed by big investment banks, such as Goldman Sachs, that now is the time to rotate funds out of low-interest bonds and zero-interest gold into conventional, high dividend-paying company shares.

Trying to match the European “fear factor” with the Goldman Sachs “greed factor” is enough to cause a headache but that’s the way it was when the owners of gold stampeded for the exit, driving the price down to $US1350 an ounce, a country mile short of the 2011 all-time high of $US1920/oz.

It is equally difficult to match the gold price plunge with what the IMF said in its stability report, which was essentially optimistic but contained a warning about the effects of excess printing of paper money by governments around the world, which are a long-term danger if continued for too long.

“The global financial crisis could morph into a more chronic phase, marked by a deterioration of financial conditions and recurring bouts of financial instability,” the IMF said.

De-coded, what the boffins at the IMF are saying is that the world might be improving, but then again it might be walking into a nastier version of the 2008 crisis, which might reasonably be interpreted as a buy signal for gold.

Bad strategies

On a separate topic, there were three situations last week, which were linked by a common thread called “bad management”.

The first was in Australia, where the “carbon trading” market faces an uncertain future thanks to poor government decisions in trying to put a price on carbon emissions as part of a climate change response but which has fallen foul of a collapse in the European carbon price.

What’s happening in carbon is a fabulous example of what can happen when a government run by people with zero business experience tries to create a market out of thin air (well, almost thin air given that the carbon being traded is in the air).

The second example comes from the US where the once market-leading retailer, JC Penney, is lurching closer to collapse as sales collapse after an ill-fated change in marketing from regular discounting to an everyday low-price model – which did nothing but confuse customers who liked the old discounting system.

The lesson from the JC Penney experience is not one of being right or wrong with a particular sales model, it’s one of avoiding sudden changes to the way you do business, especially in a very competitive market.

The final example is also from the US retail world but involves the disastrous foray by the big British food group, Tesco, which tried to change the habits of American shoppers by introducing systems which worked in the UK but which where alien to US shoppers, who abandoned the Tesco subsidiary Fresh & Easy, costing the British company more than $2 billion in losses and asset-value write-downs.

Message from those situations, think very carefully before trying to change the investing and buying habits of customers.

“True friends stab you in the front”. Oscar Wilde.