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| English: 1 oz (Troy ounce) of fine gold Deutsch: Eine Unze Feingold mit Zertifikat (Photo credit: Wikipedia) |
Financial IQ Philippines Quick Hit(s):
Historically, gold performs opposite of equities. Since most equity markets are rising, gold is declining.
Fundamental reasons behind the drop
To better understand why gold prices fell as much as they did, we will enumerate below the fundamental reasons behind it.
1. Sluggish global economic growth – With the global economy slowing down, it means that inflation is no longer a primary concern. In fact, the concern now is deflation. Hence, investment in gold has lost its priority.
2. Benign inflation – The consumer price index (CPI) numbers coming out recently are pointing towards low inflation. Since gold is viewed as an inflation hedge, this is bearish for gold.
3. Search for yield – With low interest rates brought about by global monetary easing, as well as benign inflation, investors looked for assets that can provide yield. Unfortunately, gold has no yield, making it unattractive to them. Thus, they buy high dividend yielding stocks and high yield corporate bonds instead.
4. Flight to equities – The all-time highs reached by indices in the US and the Philippines shows that investors have been allocating their funds into equities. A consequence of this move into equities is less demand for gold.
5. Shift to defensive stocks – Investors are looking for companies that have stability of revenue and earnings growth. These companies do not require a strong economic recovery to grow their earnings. This is why consumer stocks like Pepsi and Kellogg, as well as pharmaceutical companies like Johnson & Johnson and Pfizer, have been performing well in the stock market. At the end of the day, everyone still has to eat and take medicine. On the other hand, gold is cyclical in nature and has no earnings.
6. Hunt for countries with stable growth – Investors have also been searching for countries whose growth is not dependent on exports or a healthy macroeconomic environment, like the Philippines. So while gold prices have been dropping, our stock index has been making new highs.
7. Strong US dollar – The strong US dollar has caused the prices of gold and other commodities to soften. While a weak US dollar has worked to the benefit of commodity prices, its strength in the past months has caused commodities to become cheaper in dollar terms. Gold is the clearest example of this inverse relationship.
8. Fear trade waning – Investors normally flock to gold when there are fears of another financial crisis. However, the measures of central banks have alleviated these fears. Thus, investors have no more need to buy gold.
9. Insurance no longer necessary – Portfolio managers normally allocate 5 percent of their portfolio to gold. It acts as an insurance against a possible financial crisis. With the concern of a financial collapse dwindling, they began trimming their positions in gold.
10. Drop in demand from China and India – Demand for gold in India and China is also slowing. According to the World Gold Council, more than half of the world’s gold demand came from these two countries. Therefore, any drop in demand from them will have a significant impact on the price of gold.
11. Shift from commodities to equities – In a regime of low global growth, commodity funds tend to underperform. The switch from commodity funds to equity funds has also hurt the fundamental underpinnings of gold.
12. ETF liquidation – With goal losing its attractiveness as an investment or even a hedge, investors liquidated their holdings of gold exchange-traded funds (ETFs).The largest gold ETF, GLD, experienced $15 billion in outflows so far this year. As an asset-backed ETF, it would have to sell physical gold whenever investors redeem their shares, sending the price of gold spiraling down.
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