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Gold has fallen off a cliff in the last year, going from highs of nearly $1,790 in October 2012 to about $1,280 currently — a drop of about 28%.
But judging by recent trends, it's possible that gold has found a floor and that now is a decent time to buy.
Admittedly, there are still some big challenges for the precious metal — especially in the last week or so when prices have been steadily rolling back again. But even if investors are a bit early as they turn to gold, fears of overbought domestic stocks may make even an uncertain bet in gold a preferable alternative to some right now.
There's risk no matter where you put your money right now. So here are some reasons the rewards from a buy into gold may outweigh those risks:
Demand for gold bars, coins and jewelry hit a record in the third quarter, according to the World Gold Council.
This is in large part driven by strong baseline demand from China and India — which collectively represent about 60% of gold demand, according to some calculations.
Furthermore, central bank demand continues to tick higher. Russia, for instance, now holds the second largest reserves in the world with over 400 million ounces of gold in its coffers.
It's fair to say that U.S. demand for gold hasn't been that great, thanks in large part to redemptions in gold-backed ETFs (more on this in a minute) but global demand is still strong and providing a floor on gold prices.
And as some goldbugs would ask, if folks around the world from China and Russia think it's a good idea to accumulate gold right now… shouldn't you?
An added boost: we are entering a time of seasonal strength for consumer gold purchases, across the Christmas holidays in the U.S. and Europe, the Lunar New Year in Asia, and then Valentine's Day again in the U.S. That should shore up demand even more.
Regarding Western demand, obviously gold appetite has been driven in recent years by gold-backed funds. When investors were buying these instruments like the SPDR Gold Trust (GLD), demand was high… and when they weren't, demand plummeted.
But the pace of outflows from gold funds was dramatically lower in the third quarter — down to 119 metric tons of the precious metal vs. roughly 400 tons in outflows in the second quarter.
And it's important to remember that while overall demand is down 21% year-over-year in the third quarter of 2012, gold prices peaked for the year at the end of the third quarter last year so it's unsurprising to see a greater than 20% drop in demand when prices themselves are down more than 20% in the last 12 months. Going forward, the year-over-year comparisons regarding demand will be in favor of the gold bugs since most of the selling from speculators has already been recorded.
For the record, I'm not convinced there is a difference between gold bars and "paper gold" funds. After all, if you own the PowerShares QQQ Trust (QQQ) you do indeed own Apple (AAPL) stock — not "paper" Apple shares, but actual stock through this ETF's constituent holdings.
I'm more concerned with trends, and a look at recent outflows clearly indicates that sellers are losing steam and the bottom may be in. And more importantly, that we will soon be back into inflow territory as we stop comparing gold investing with prices over $1,700 to the gold market now.
Recently, prospective Federal Reserve Chairwoman Janet Yellen has made no bones about the importance of keeping the pedal down on loose monetary policy under her watch. See "Easy money winners and losers."
That coupled, with Ben Bernanke backing off his hints of a "taper" a few months back, has helped tamp down gold's strength since summer.
But the fact remains that quantitative easing bond buying can't carry on forever. Or as Yellen said in her confirmation hearing, "I believe that supporting the recovery today is the surest path to returning to a more normal approach to monetary policy."
I read that not as a sign that the Fed wants to keep quantitative easing in place forever, but that the Fed very much wants to return to "normal" policy.
Keep in mind that gold rallied from a low of under $1,200 at the end of June to $1,400 in August on the expectation that tighter monetary policy was on the way.
A move like that may be likely again for gold prices in early 2014.
Now, the hyperinflation crowd that has beating the drum about rising prices hasn't had much luck with its arguments since the financial crisis. But there's a difference between a swing trade in gold and a belief that America is bound for the same fate as Zimbabwe — and the former strategy can pay off if you time it right.
It's fair to write off the bullish case for gold as stubbornness. After all, some traders have been convinced gold "has" to go higher in this environment… and have been painfully wrong across the last 12 to 18 months.
But not all gold bulls are the hysterical type. Hedge fund manager John Paulson, despite cutting his gold holdings in half, remains heavily invested in the precious metal. And investing icon George Soros revealed in his hedge fund's latest filing that he has moved back into gold funds recently — and is decidedly bearish on equities.
There are a host of emotional arguments about gold — that it is "real" money as opposed to fiat currency, that "paper gold" investors are manipulating the market — but the presence of real buyers with a lot of cash to deploy is a real case for gold.
This doesn't mean that gold can't move lower. Though the bunker crowd would like to believe otherwise, gold is a decidedly speculative commodity investment and volatility is the name of the game.
Furthermore, a lot of misinformation and spin exists out there — chief among them the idea that gold cannot fall below its "extraction cost," and that megaminers like Barrick Gold Corp. (ABX) can simply go dark for a few months until prices stabilize. And in a sentiment-driven asset class, sometimes the narrative matters as much as hard data.
But now that gold has been stuck between about $1,400 and $1,260 since the end of August, it may be worth considering a bargain buy now that gold prices are once again at the bottom of that range.
Gold can always go lower, yes. But so can domestic equities, emerging market stocks or other asset classes.
The key question, then, is whether you want to keep chasing the S&P 500 (.SPX) or you want to start considering other assets.
Me, I'm starting to take a good look at gold.
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