Where next for the yellow metal?

Gold experts Georges Lequime and Paul Tustain, both speaking at City A.M.’s Active Trader Conference this year, give their perspectives on recent moves in the price, what drives the precious metal, and what will happen next

GEORGES LEQUIME

FOR the first time in my twenty years as a gold fund manager, and previously sell-side analyst, I find myself at a loss to understand the dynamics of the bullion market.

Until last week, gold’s recent malaise was easy to explain: the rally in broader markets was attracting the attention of retail investors, and hedge funds were chasing other momentum trades, like shorting the Japanese yen.

In recent years, the main attraction of gold was as a hedge against currency debasement. Since less than 175,000 tonnes of gold have ever been mined – this figure only increases by 1.8 per cent annually – gold is difficult to debase, and is an attractive alternative to the low or negative yielding dollar, yen, and euro. But as US economic data improved and inflation has stayed low, the dollar has rallied, making gold a hard sell. And even the Cyprus crisis didn’t faze gold, as the European Central Bank indicated that it was shifting away from loose monetary policy.

Nevertheless, gold’s recent collapse has been puzzling. Almost in tandem, several bulge-bracket banks recently downgraded their outlooks for gold, and advised their clients to sell. But their arguments are weak, and could easily have been applicable a year, two years, or three years ago. It is hard to explain why these banks collectively became so negative when there had been no major shift in fundamentals.

But last Friday, almost 400 tonnes of gold was off-loaded onto the futures market in a very short space of time. The staggering scale of this sale – around 15 per cent of annual global production – suggests that a single party, or a few large players acting collectively, may have been responsible. Interestingly, short-sellers of gold would have needed to put around $1bn (£656m) on account to place this trade, which is an extraordinary bet without a material change in the fundamentals of gold.

Am I missing something? Surely after the emergence of some weak US economic data, and the threat from North Korea, gold should be attractive. But instead, we witnessed the largest two-day fall in gold prices since 1983.

However, I am still not convinced that the price of yellow metal will remain below $1,500 for long. Gold demand hit a 48-year high in 2012, and increased further at the beginning of this year.

And do not underestimate the affinity for gold in China – which doubled imports of the yellow metal in 2012. China’s official gold reserves now stand at over 1,000 tonnes, and make up less than 2 per cent of its foreign exchange reserves. And China has indicated that it intends to further diversify its foreign exchange reserves, which should be positive for gold.

But the main reason why I believe gold prices will not remain below $1,500 is because, on average, it costs around $1,460 to produce a troy ounce of gold. The last time that gold dipped below its production price was in 2000, just before prices started their meteoric rise.

So I am convinced that there is a strong case to hold gold. Record high debt levels in developed nations, massive amounts of monetary easing, negative real interest rates, and challenging global labour markets are all supportive of gold.

The market seems to be getting ahead of itself here, and it is easy to make a case for higher gold prices from these levels.

Georges Lequime is lead adviser to the Earth Gold Fund.

PAUL TUSTAIN

I HAVE personally lost 14 per cent on my gold trade since 2 April. It is by far my largest investment holding, and I am taking a hit.

But markets overshoot, and they can correct both ways. I remember gold’s dizzy peak on 6 September 2011 was followed by a $400 reversal in the three weeks that followed. I am also reassured by the fact that currencies which are run by indebted countries with extreme fiscal problems tend to eventually tumble into spectacular failure – this will support gold.

Of course, this is insight is neither unique, nor brilliant; but it underpins many investors’ strategies. We shouldn’t be too surprised when a few traders sell during these counter-trend phases of what is transpiring to be a complicated journey for gold.

But here’s a thought which helps me to keep my cool: as a currency fails, those who will succeed in hanging onto their wealth will be the ones who acted decisively as the storm gathered. These investors will have been through the mill, having endured countless hours of anguished doubt. But when the market tests their resolve and moves against them, providing that they fundamentally have confidence in their original judgement, they will hold firm. This is what it will take to be a successful investor sailing through the failure of a monetary system.

I remain convinced that I am on the right side of sterling’s long-term decline, even though market commentators will, for a while, be proved right in their bearish assessment of gold. In time, however, I expect the upturn to be as sharp as this setback. Were I to sell before that point, I doubt I could trust myself to switch from the depreciating sterling back into gold at higher prices. It would just be too painful.

Markets don’t offer smooth passages. They pitch up after each trough and slump over every crest. It can get rough, so you must batten down the hatches, and trust that she’ll take the beating. And with gold, I believe she will, if you hold your course.

Paul Tustain is founder of Bullion Vault. www.bullionvault.com

Active Trader conference on 21 June 2013 at The Grange Hotel, Tower Bridge, London E1 8GP. Early Bird Tickets are now available for just £45 from www.CityAMactivetrader.com