Spot gold climbed back above $1,930 in intraday Asian trading on Thursday. The move comes two days after a sharp drop in gold prices spooked investors.
Has the gold bubble been pricked?
On Tuesday, spot gold fell 5.7 per cent, its biggest fall in seven years, a significant plunge for an asset that rarely moves more than a percentage point in a day. Gold fell further on Wednesday, falling to a low of $1,863, breaking an extraordinary rally.
Bullion rose to a record high of $2,074 earlier this month after breaching its long-term ceiling of $1,350 in June last year.
Still, much of the bull market of the past year has been a long overdue correction at depressed levels. Just as gold hasn’t fallen below $1,000 since 2009, despite a long slump for most of the past decade, it isn’t likely to fall below $1,700 again once the current volatility fades.
The reason for this is not to hedge against inflation or deflation — those who bought this view when US consumer prices were rising at double-digit rates around the time of gold’s real peak in 1980 are still investing far less than they expected.
A better explanation is that gold accounts for a fairly stable share of global liquid portfolios and that much of the recent surge in the price of gold is simply reversion to the mean.
Add up the value of the world’s stock markets, the value of the world’s outstanding bonds and 42,619 tonnes of privately invested gold, and you have nearly $200 trillion of liquid investment assets.
Over the past five years, gold’s share of these bonds, collected through Bloomberg financial data, has been fairly steady at about 1.09 per cent, rarely below 1 per cent or above 1.2 per cent.
This is similar to the gold allocation recommended by many fund managers. For all its false advantages, gold has one truly useful feature – its unrivalled ability to move in the opposite direction to equity and bond yields.
Negative beta means that a small amount of gold in a typical portfolio can help smooth the peaks and troughs of the market cycle and deliver better risk-adjusted returns over the long term.
This constant allocation translates into market prices, rising 50 per cent in little more than a year, because the size of these asset classes varies so widely.
Even if participants in the $88tn stock market and $108tn bond market turn slightly to metals, the impact of funds pouring into the $2.8tn private sector will be huge.
There is no doubt that gold is defying gravity at its current level, as is any investment that is controlled by speculative momentum. But with gold below $1,900, we have come quite a way down.
Liquid assets have been growing at about 6 per cent a year since 2015, with incremental gold demand reaching about 1,250 tonnes a year.
If allocations fall from 1.38 per cent to the long-term average of 1.09 per cent, the fair value of gold would be in the $1,600 range this year and next, rising to $1,800 around 2015.
In other words, gold may still fall from its current highs, but it may not have much further to fall.