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Gold, the metal that rallied during every US recession in the past three decades, may drop to a two-year low as the threat of deflation curbs bullion's appeal. In past recessions, investors found value in gold.
03 Nov 2008
By Jon Nadler
The new month started out on a slightly more upbeat note for precious metals, although no major changes were detected in the overall trend that dominated an October to forget. The US dollar slipped lower on the index, touching 85.10 this morning. However, the radar indicates that the ECB may be about to embark on the swiftest rate-cutting campaign since it birth a decade ago. Europe is already in a recession -whether or not such an event is recognized by its leaders-and it will likely stagnate for most of next year. The euro therefore cannot look very appealing in the medium-term, and even if the dollar is not in showroom condition, it continues to attract fresh holders.

The US is still in the midst of whatever this economic contraction will ultimately be labeled as, and it bracing for more distressed earnings reports this week. Citi warned today that its credit card losses may mushroom next year as consumers who reached for the plastic to buy more things they really did not need, are rapidly sinking into financial quicksand. Something else that is sinking, is China's manufacturing activity. CLSA Asia-Pacific Markets reports that its China Manufacturing PMI fell to 45.2 from 47.7 in September, marking its third straight monthly decline, and the fastest such drop recorded in the survey's history. So much for "ChIndia" being immune to the rest of the world's slowdown.

New York spot gold prices opened their first November session with a $7 gain, quoted at $731 bid, as participants were still looking for a clearer direction and new strategies that might work in their favor after such a bad October. Open interest in gold shrank further during the week that ended on Thursday, as investors are warming up to the time-honored 'strategy' of stuffing cash under the Serta. Silver bullion opened with a one penny loss at $9.85, while platinum rose $12 to $831 per ounce. Palladium marked time at $195 per ounce, as the complex still awaits some kind of resolution on the immediate fate of GM and Chrysler. Ford stated that it believes it can make a go of it on its own -for now. Must be running on run-flats.

The liquidation mania and related selling pressure we have seen for many an October session may yet make a return, as the prospects for price declines in industrial metals and energy remains at the forefront of economic forecasts. Whether or not the US dollar benefits from a post-election afterglow, remains to be seen. We only need to wait one more day for that to happen. The unemployment data rolling towards the markets in the latter part of this week may be the final straw to usher in another possible stimulus package, and who knows what else.

So, what can we make of the cratering in commodity prices, and how is gold supposed to behave at such a juncture? Bloomberg's Millie Munshi, Pham-Duy Nguyen, and the Financial Times jointly bring us their take on the situation this morning - along with the opinions of various people in the commodity and asset management trenches:

"A record plunge in commodities may signal the U.S. is headed for the longest recession since 1981, just after Ronald Reagan became president and the economy began a 16-month slump. Industrial raw materials measured by the Journal of Commerce fell at an annual rate of as much as 56 percent last week, the most since 1949 and worse than the declines before every recession since then. Crude oil, copper and wheat tumbled more than 50 percent from records this year as the U.S. economy declined in the third quarter by the most since 2001.

``The industrial sector, which was helping to keep the recession relatively mild, has completely given way and now we need to be prepared for a much more severe recession,'' said Lakshman Achuthan, managing director at the Economic Cycle Research Institute in New York, which compiles the Journal of Commerce data. ``It's at least going to look something like what we saw in the early 1980s, but it could be worse.''

Goldman Sachs Group Inc., once among the biggest commodity proponents, said Oct. 23 the risk of a ``sharp global economic slowdown'' may send prices even lower. Codelco, the world's largest copper miner, said this year's price collapse signals the end of a ``supercycle'' for the metal. The commodity slump is ``indicative of a global growth scenario with slower growth than what we've seen in more recent recessions,'' said Walter ``Bucky'' Hellwig, who manages $30 billion at Morgan Asset Management in Birmingham, Alabama. ``It's probably best to be underweight commodities now. Where the money goes is into defensive holdings, like consumer staples and stocks that benefit from lower commodity prices.''

``People say that copper is the commodity with a Ph.D. in economics, but really all you have to do is look at the price of any commodity right now to realize that the world is definitely in a recession,'' said Michael K. Smith, president of T&K Futures & Options in Port St. Lucie, Florida. ``Anyone paying attention to these markets is scared to death right now.'' Declines in raw-materials prices are linked to manufacturing slumps that compound economic slowdowns.

While the National Bureau of Economic Research, the Cambridge, Massachusetts-based official arbiter of U.S. economic cycles, has yet to call a recession, the CRB raw-materials index plunged 29 percent since its peak in May. During the same period, U.S. factory production declined three straight months, ending five years of gains.

The commodity decline coupled with economic data signal the current slowdown will last at least 16 months and spur slowdowns globally, not just in the U.S. and Europe, ECRI's Achuthan said. The slumps of 1990 and 2001 lasted eight months, according to NBER data. ``As is usually the case, the commodity index is ahead of consensus right now and indicating just how deep and how long this global recession will be,'' Achuthan said.

Investors should sell commodity holdings and buy equities because raw-materials prices will fall further, said John Wilson, a co-director of equity research and chief market technician for Morgan Keegan, which manages $120 billion in Memphis, Tennessee. ``Commodities aren't the place to be any more,'' Wilson said. ``They did outperform equities for some years, but it's difficult to make the case for commodities now until we see the trough of a recession.''

Gold, the metal that rallied during every U.S. recession in the past three decades, may drop to a two-year low as the threat of deflation curbs bullion's appeal.

The number of gold futures held in New York plunged 48 percent since its Jan. 15 peak, according to data compiled by Bloomberg. Prices fell 17 percent last month to $724.55 an ounce in London. The metal may drop to $600 by yearend for the first time since 2006, said Joel Crane, a Deutsche Bank AG strategist in New York.

While gold rose since 2000 as the world economy expanded and the dollar weakened for five of the past six years, the Reuters/Jefferies CRB Index of 19 commodities lost 43 percent since reaching its peak in July as the seizure in credit markets caused economies around the world to slow and the U.S. to contract 0.3 percent in the third quarter. Rather than providing safety for investors, gold declined almost 31 percent since reaching a record $1,033.90 an ounce in New York on March 17.

``Gold is not considered a safe haven because investors are viewing it as part of the commodity class,'' Crane said in an interview. ``Commodity is a bad word right now. Through this whole credit crisis mess, cash has been king.''

Deutsche Bank expects gold, down 13 percent this year in London, to average $861 in 2008 and $750 next year. UBS AG last week lowered its 2009 forecast to $700 from $825. Gold for immediate delivery averaged $887.31 this year.

Gold rose about 220 percent this decade through June as expanding economies, especially in emerging markets, spurred demand for commodities and increased risks of inflation. While the CRB index rose more than 125 percent during that period, the Standard & Poor's 500 Index fell 13 percent and the U.S. Dollar Index, which measures the currency against six of its biggest trading partners, weakened 29 percent.

Demand for gold waned amid speculation that U.S. government efforts to rescue the banking system and the Federal Reserve's decision to lower its target interest rate for overnight loans between banks to a 50-year low of 1 percent will help the world's biggest economy recover faster than Europe. The combination of falling commodities and rising demand for dollar- based assets ended gold's bull market.

Dennis Gartman, an economist and editor of the Suffolk, Virginia-based Gartman Letter, exited all his gold positions, except for coins he purchased at the end of September. ``I feared the whole financial system was coming to a halt, and you need a little gold in that case,'' he said. ``I doubt it will anymore. But it sure felt like it a month ago. There's no value in gold right now.''

That hasn't stopped some investors from pouring money into gold. The SPDR Gold Trust, the biggest exchange-traded fund for the metal, climbed to a record 770.6 tons on Oct. 10. A one- ounce Krugerrand coin from South Africa cost almost $29 an ounce more than the spot price of gold Oct. 27, compared with a less- than-$5 premium at the start of the year. Zuercher Kantonalbank, which manages about $107 billion in Zurich, said Oct. 15 that its gold vault was full after a surge in demand.

``The wonderful thing about gold is that you still have willing buyers,'' said Paul Sutherland, chief investment officer for Traverse City, Michigan-based Financial & Investment Management Group, which manages about $540 million and has 5 percent of its assets in the metal. ``One of the first things people will buy once they take their heads out of the foxhole is gold. It can take on a life of its own and go to $1,000, $2,000.''

Gold in New York was the sixth-best performer in the CRB Index. Nickel fell 54 percent and oil dropped 29 percent. Only sugar and cocoa are up for the year.

``Gold's being treated like any other asset right now, it's deflating,'' said Ralph Preston, a futures analyst at Heritage West Futures in San Diego who had predicted a rally to $1,150 by yearend. ``I'm exercising patience and looking over a longer time horizon for gold to regain, in the eyes of the market, its status as a safe haven.''

While gold may drop as low as $600 next year as investors raise cash to cover losses in other markets, a record $1,500 an ounce is likely in three years as central banks spend more than $1 trillion to end the credit crunch, setting the stage for faster inflation, said Peter Tse, head of precious metals trading at ScotiaMocatta in Hong Kong.

Mario Innecco of MF Global U.K., who in March expected gold at $1,200 by yearend, said the range now is $850 to $950. ``All the Western central banks have guaranteed the banking system,'' Innecco said from London. ``The cost is going to be higher inflation and paper currencies will be worth less.''

In past recessions, investors found value in gold. The metal gained 78 percent from November 1973 to March 1975; 20 percent from January to July 1980; 2.3 percent from July 1981 to November 1982; 1 percent from July 1990 to March 1991; and 2.7 percent from March to November 2001.

For now, investors prefer paper. Foreign accounts, including central banks, raised their holdings of Treasuries to $1.6 trillion in the week ended Oct. 29, up from $1.5 trillion at the start of the month, Federal Reserve data show. U.S. debt returned 4.6 percent in 2008 and the dollar is up 15 percent against the euro, heading for the biggest annual jump since the European currency's debut in 1999.

``Under deflation, cash and highest-quality bonds are the asset class of choice,'' said Marc Faber, publisher of the ``Gloom, Boom & Doom Report.''

Gold rallied 31 percent last year as the U.S. inflation rate reached 4.1 percent, the most since 1990. The threat of accelerating prices moderated as commodities from oil to corn to rice plunged from records in the past four months. The Labor Department's consumer price index was unchanged in September after a 0.1 percent drop in August.

Commodities producers are among this year's worst- performing U.S. stocks. The materials group in the S&P 500 fell 40 percent this year while the Philadelphia Stock Exchange Gold & Silver Index of 16 mining companies plunged to a five-year low on Oct. 24.

Toronto-based Barrick Gold Corp., the world's largest producer, fell 29 percent on the Toronto Stock Exchange in October, the worst month in 21 years. Phoenix-based Freeport- McMoRan Copper & Gold Inc. plummeted 49 percent.

``We haven't had a deflationary recession since the 1930s,'' said Leonard Kaplan, president of Prospector Asset Management in Evanston, Illinois. ``Equities will fall, consumers will spend less, and demand for commodities will just keep going lower.''

Gold prices continue to perform counter-trend for a recession. As Bloomberg points out the metal, which previously rallied during every US recession in the past three decades, is refusing to rebound as a safe-haven should. Instead it’s notched up a 30 per cent decline since a peak of $1,000 an ounce in March, and is now heading for a 2-year low.

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19 Apr 2011
I really appreciate your post and you explain each and every point very well.Thanks for sharing this information.And Ill love to read your next post too. regards
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