Bull’s gold

In the depths of what is still, for many people, a real-terms recession, it seems somehow incongruous to be confronted by a wall of coverage on one of the world’s most expensive precious metals. But look anywhere right now – in PF sections, market round-ups, news analyses; you name it – and gold will be in there, lurking expensively. And it is not hard to understand why.

At the time of writing, the gold price had crashed through $1,300 an ounce. As the FT points out, that’s still a long way from bullion’s 1980 inflation-adjusted high of $2,300, but it still represents an 18% advance since the turn of the year. To put that in perspective, over the same period, the S&P 500 index has risen around 2%. Quite simply, gold is the only real bull market in town.

Why has bullion done so well while other assets classes have not? Future inflation is one reason. Gold is a classic inflation hedge, and although US inflation – in contrast to the UK – is currently extremely low, investors have been betting since the turn of the year that this will not be the case forever, particularly with more quantitative easing on the horizon.

Another reason is that gold is considered to be a good hedge against equity volatility, being less synchronised with economic cycles than other commodities. Bullion’s ‘safe haven’ status has, against a gloomy macro backdrop and an uncertain outlook for many asset classes, seemingly appealed to a wide spread of investors; not least hedge funds, which have – and reportedly continue to take – major positions in the metal. Moreover, with year-end performance reports looming large, many managers are anxious to deliver strong H2 returns following a generally painful summer. Gold, with its largely unbroken upward trajectory in 2010, must to those investors seem like a particularly appealing option right now.

While these short-term factors – and some major countries’ willingness to competitively devalue their currencies – have recently driven gold to new highs, bullion has not, of course been a Johnny-come-lately success story. Indeed, as Bloomberg points out, gold is homing in on its tenth consecutive annual gain – outperforming, in the process, global equities and US Treasures, among other asset classes – which would represent its longest winning streak since 1920. And few investors seem to believe the party will end any time soon. In fact, some of the industry’s leading managers have positioned their funds to benefit from future gains in the metal, while one wealth management boutique is so sold on gold that it insists all clients allocate 5%-15% of their portfolios to it.

Bullishness, then, abounds. But how long can the rally really last?

Last Tuesday, gold received a major fillip when the US Federal Reserve cast aside its coyness on QE2 and finally suggested it was prepared to embark on a fresh round of expansionary monetary policy. More quantitative easing would be good for gold because it would reduce the value of the dollar, to which the metal is inversely correlated. The prospect of central banks buying more government bonds in vast quantities has convinced some traders that, far from hitting a plateau, the gold price could eventually reach the giddy heights of $1,600 an ounce. Traders are far from alone in their enthusiasm. With negative comment on gold generally hard to find in most press articles, journalists are clearly struggling to find anyone willing to express a bear case opinion of any kind.

The reason for this dearth of party poopers might have something to do with investor inflows, or, at least, the nature of them. Analysts are reporting that the flood of new money into gold stems chiefly from long-term investors, rather than ‘hot money’ speculators seeking to turn a quick profit. With imminent sales out of the equation and little sign of short positions being put on, support for a sustained upward move should be firmly in place. But for how long? George Soros has stated that a meltdown is only a matter of time, having described gold the ‘ultimate bubble’. That gloomy statement may, one day, prove to be correct. But don’t expect the gold story, in one shape or form, to lose its shine just yet.