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Gold drops. Time to buy?

The decline might be a buying opportunity, or there could be more room to fall.

  • Fidelity Active Trader News
  • – 04/29/2013
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Is gold's streak of 12 straight yearly gains in jeopardy? On April 12 and April 15, 2013, the yellow metal saw its worst two-day decline in three decades, sending it near the lowest levels since February 2011. And the roughly 13% two-day drop comes on the heels of an already slow start to the year for gold (see the chart right). Currently, gold is trading around $1,450 per troy ounce, down more than 12% for the year.

Gold's decline stands in sharp contrast to the major rally seen in equities this year; the S&P® Index is up 11.4% on a total return basis in 2013 as of late April. Has the precious metal’s allure dulled as other assets have become more attractive? Or has the drop made gold even more attractive?

We look at some of the potential causes of the sell-off, as well as historical evidence that might shed some light on which direction gold could go now.

What caused the sell-off?

One reason behind the recent softening in gold prices could be that demand from India, the world’s largest consumer of gold, has moderated in recent months after the government increased several import duties on gold. In 2013, gold imports fell 24% from January to March in the world’s second most populous nation.1

The sharp two-day sell-off may have been the result of several concurrent factors:

  • Debt-riddled Cyprus announced plans to sell a large amount of “excess” gold reserves to secure bailout loans.
  • GDP reports showed slower-than-expected growth in the U.S. and China, the world’s two largest economies. China is the world’s second largest consumer of gold.
  • Investors sold gold to potentially seek better returns elsewhere, such as in the equity markets.

Long-term strength

Despite the sell-off, investors might want to be careful not to overreact to what’s happened to gold this year. The gold industry can be extremely volatile, however, it is an asset class that can play a valuable role for investors in a diversified portfolio.

Taking into account the multiyear uptrend that has been in place since 2001, the recent decline has had a relatively minimal impact on the returns of long-term buy-and-hold gold bugs (see the chart right). Since March 2001, gold is up a staggering 438%.

Indeed, fundamental factors may support the notion that gold could continue its uptrend. Historically, gold has done relatively well when the rate of U.S. inflation is greater than interest rates, as it is now. Additionally, gold tends to benefit during times of geopolitical strife, as well as when central banks are enacting easy money policies.

Jurrien Timmer, co-manager of Fidelity® Global Strategies Fund, believes that the current low level of real interest rates and central bank activism should have gold trading near $2,000 per troy ounce, versus the current $1,450 per troy ounce price.

Says Timmer: "$1,300 may be a strong support level for gold. We came very close to that in mid-April, hitting $1,322. In my view, having not broken through that price and considering that the price is trading at a steep discount, the risk-reward of gold appears very compelling on the upside."

Of course, if gold were to drop below that $1,300 support level, it could have bearish implications. Nevertheless, Timmer has a positive outlook. "I think gold remains an attractive asset class, especially at current levels."

The rapid two-day price drop did cause certain short-term technicals to signal a buying opportunity. After the sharp decline, gold’s relative strength index, a measure of short-term investor psychology, hit the lowest level in 30 years. This buy signal may have played a role in the modest rebound since the steep decline as gold is now trading above $1,450 per troy ounce.

Factors to watch

Is the secular bull gold market over? Clearly, there are risks to the downside. Gold has already lost close to half of its post–financial crisis gains, and is roughly $500 below the September 2011 all-time high.

Still, gold’s recent decline may be reminiscent of what happened during the financial crisis when a drop in gold futures and ETFs—two assets that reflect the demand for gold—was followed by a strong rebound.

  • Gold futures are currently down roughly 63% off the August 2011 highs. In 2008, they came down 75% from July to November.
  • Gold ETFs are down about 10% from early January 2013. In 2008, they were down 9% from July 21 to September 16.

These may be significant demand comparables to watch because, following the October 2008 gold bottom, over the next two-and-a-half years, gold prices surged 110%, and gold stocks strongly outperformed the bullion.

You should carefully weigh all the relevant factors that can influence gold before deciding which direction it could go. Supply and demand remains the most important determinant of the price of gold. Demand from Asia, for example, appears to have picked up in recent days as bargain hunters have gone shopping. The Shanghai gold exchange set a record high for volume on April 22 of 43 metric tonnes.2 The demand for dollars (a strengthening dollar is typically bearish for gold, and vice versa) is another important fundamental force that guides gold.

While the dynamics of these relationships may not have shifted dramatically enough to induce the type of movement that was seen on April 12 and April 15, 2013, traders must now assess gold at its new, significantly reduced price.

Learn more

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1. Source: Reuters
2. Source: Bloomberg
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