Why gold bugs are getting bitten


GOLD bugs come in all forms. Two years ago, while gazing at the Singapore skyline from dizzy heights, a company executive shared the story of his giddy bullion ride with me. It had clearly delivered a better rush than our steep ascent in the elevator to look out at the booming city state. And he wasn’t the only one convinced to stash bullion; in fact, investors far and wide were coached into thinking they were not diversified unless they owned gold for insurance.

The new norm for investing had one fund manager after another telling clients to expect single digit returns from a low equity exposure. They were advised to park a large chunk of money in low-return assets (like fixed income or cash) to ensure return on capital, and to dust off their portfolios with protection from another meltdown, or spike in inflation, in the form of gold holdings. Even non-gold enthusiasts shrugged off concerns that bullion offered no yield. And gold enjoyed an unprecedented rally, driven partly by fears of central banks destroying paper assets and printing money. Bullion has gained more than 60 per cent in five years.

But gold’s ongoing ability to play chameleon has broken down in recent weeks. The precious metal previously displayed the remarkable trait of rapidly changing its stripes, running with the risk-on crowd and then sailing higher when sentiment fell. Those days are over, however, as asset managers, hedge funds, private banks and retail investors look to reduce holdings.

Gold has been swept up in the current of the Great Rotation from fixed income to equities, as markets eye the pace of Federal Reserve asset purchases and a likely climb in real interest rates. It has led to a tide of outflows from gold exchange tracker funds, and to the spot price being battered by the change in asset allocation. Previous proponents now say gold offers little store of value, as the global economy has stabilised and the upsurge in inflation has been limited, rendering bullion an unnecessary insurance.

There is no doubt some hedge funds are suffering, and gold exposures are compounding the problem. Hedge fund billionaire John Paulson – famed for his contrarian bets – is thought to be wearing large losses on his three year old Gold Fund, with reports estimating that more than a quarter of the fund’s value has been destroyed this year.

But is this a short-term volatility problem or is the gold trade done for the decade?

Nomura is one house that last week alerted clients to a lower price target for 2013 – previously it was calling $1,981 an ounce, but has now stripped the target back to $1,602. And it’s not alone. Goldman Sachs and Bank of America Merrill Lynch have similar targets. The issue is that gold has been below this target and could remain there if the selling continues. Curiously, Nomura’s 2014 and 2015 calls are largely unchanged at $1,750 and $1,600. But with a caveat that “2014 prices are likely to be heavily dependent on how 2013 prices develop”, this leaves a lot of room for adjustment.

Patrick Legland, head of research at Societe Generale, admitted last week that he is “scared” of what the unwinding of gold positions could mean for the metal. What’s scary is that it was a supposed safe haven.

Karen Tso is an anchor for Squawk Box Europe on CNBC.