Gold's bull run may not bear up

Metal's price soars on negative interest rates but global economic woes may reverse rush

Gold looked like a dead loss four months ago when its price dropped precariously close to the US$1,000 (S$1,360) an ounce support level but its fortunes have picked up dramatically since.

Its price has climbed by as much as 17 per cent against the greenback, 16 per cent against the Chinese yuan, 9 per cent against the Japanese yen and 14 per cent against the Singdollar over that period.

The run-up has led the World Gold Council (WGC) to muse about the emergence of a new golden era for the precious metal.

"We believe that market uncertainty and expansionary monetary policies will continue to support both investment and central-bank demand," it stated in its latest quarterly report recently.

"This, combined with an analysis of previous bull-bear cycles, suggests we may be entering a new bull market for gold."

A Chow Tai Fook outlet in Hong Kong. The city's top jeweller reported that retail sales fell by nearly a third in mainland China and almost a quarter in Hong Kong and Macau between Jan 25 and Feb 14, the period straddling Chinese New Year when brisk sales are traditionally the norm. PHOTO: BLOOMBERG

Is the WGC correct in arriving at such an assessment? Some will say it may be too premature, given that gold has produced a sparkling showing for only one quarter.

A number of factors led to the run-up in gold prices, chief among them being concerns over negative interest rate policies pursued by central banks in Europe and Japan.

As the WGC rightly points out, such policies reduce the opportunity cost in holding gold as investors stare at up to 10 years of negative returns for sovereign bonds in Switzerland and Japan, and five years for bonds in Germany and France. This makes holding gold attractive even though it offers no income.

And the objection about the costs of the elaborate security measures to store gold in a safe place is overcome by the establishment of exchange-traded funds (ETFs) by big fund management firms such as State Street Global Advisors and BlackRock. These charge a small fee for holding the metal.

Such funds give investors a low-cost way to buy into gold and trade it like shares on a stock exchange.

That may explain why as negative interest rates take root in many of the world's major economies, big-time traders and hedge fund managers have been piling into gold ETFs.

SPDR Gold - the world's biggest low-cost gold fund - for instance, reported that in the first 2 ½ months this year, it attracted nearly US$7 billion (S$9.5 billion) of new investments.

SGX data shows it is also the most actively traded ETF in Singapore, with about $220 million changing hands so far this year, a hefty 68 per cent increase over the same period last year.

In all, investors had snapped up a combined 363 tonnes of gold across the globe in the first quarter. This is more than all the gold they sold last year as its price spiralled downwards.

And it is not just fund managers who have become committed gold bugs. Even retail demand for gold coins has picked up, according to the WGC. "Combined sales of 22k (Eagles) and 24k (Buffalos) gold coins by the US Mint increased 51 per cent in the first quarter," it said.

Yet the bullish backdrop painted by the WGC is tempered by flagging demand for gold among consumers in big countries like China, whose seemingly insatiable demand for jewellery has always been one key reason for investing in the metal.

It turns out that the same disturbing macro-economic trends that have been fuelling interest in gold among fund managers may be the reason for keeping people out of jewellery shops.

One worrying sign of consumers preferring to hang on to their cash - as the economic fundamentals deteriorate - comes from Hong Kong's top jeweller Chow Tai Fook.

Its retail sales dropped by nearly a third in mainland China and almost a quarter in Hong Kong and Macau between Jan 25 and Feb 14, the period straddling Chinese New Year when brisk sales are traditionally the norm.

There is a further concern worth highlighting: Just as fund managers were quick to snap up gold in the first quarter in the wake of bearish sentiment about the world's economy, they may well be as fleet-footed in making their exit when the outlook brightens again.

Just consider what transpired in the past 10 years: Holding gold had been a good bet in the years immediately after the global financial crisis in 2008 as the US Federal Reserve and other major central banks depressed interest rates effectively to zero to try and nurse economies back to health.

This caused gold prices to almost triple to a record high of US$1,888 an ounce by June 2011 as fund managers piled into ETFs in a big way - like now.

But fortunes took a big hit three years ago when the Fed flagged its plan to turn off the massive liquidity it had unleashed on the financial system by scaling back on the US$85 billion of fresh money it was then printing each month.

It caused gold prices to fall almost a third in the following months as traders and big-time hedge fund managers unwound their huge ETF positions. This was despite consumer demand for gold staying buoyant in India and China over the same period of time.

And since it offers no return, gold suffered a further sell-off last December, as the US central bank made its first rate hike in almost a decade.

This in turn made US government bonds a more desirable investment, given their higher payoff. Hence, the dramatic comeback by gold may also be partly due to the Fed toning down its language on future rate hikes this year.

Still, one question that needs to be asked is whether gold will make a good investment should the world's economy really fall into a depression, as worried central bankers appear to be signalling with their frantic efforts to push interest rates deeper and deeper into negative territory. As investment guru Warren Buffett once pointed out, one can take all the gold ever mined in the world and it would fill a cube about 22m in each direction.

And emphasising the cube's lack of usefulness, he observed that "it doesn't do anything but sit there and look at you".

Instead of investing the money in gold, he suggested putting it to more productive use like investing in companies and farm lands whose value would appreciate over time as their businesses prosper.

To Mr Buffett, holding gold offers little real economic value. He has a point. In a stalling economy, even gold may find itself coming under pressure eventually. The flagging demand in the jewellery shops in China and Hong Kong may just be a harbinger of things to come.

A version of this article appeared in the print edition of The Straits Times on April 18, 2016, with the headline 'Gold's bull run may not bear up'. Print Edition | Subscribe