Gold: It's Just a Metal, Folks

Despite its recent pullback, gold's bull run, which began more than a decade ago, has rewarded those who owned it through the financial crisis. For investors willing to put up with intermittent declines -- some of them substantial -- gold has lived up to its billing as a "safe haven" asset. Will it continue to live up to that reputation? Perhaps not, as recent evidence suggests that it has been relegated to the ranks of its grubby commodity peers. If you own gold on the expectation that it is an effective hedge for the rest of your portfolio, now is the time to re-evaluate that premise.

Safe haven or risk asset?
Over the past eight months, as I monitored the financial markets in the backdrop of the eurozone crisis, I've been repeatedly puzzled by gold's behavior. As Mr. Market was once again subject to schizophrenic "risk on/risk off" moods, gold was consistently putting up losses on "risk off" days -- contrary to expectations. In fishing around for explanations, I must tip my hat to the Financial Times' James Mckintosh for providing one possible interpretation of this phenomenon.

Let's compare gold's performance to that of the Dow Jones-UBS Commodity Index, which, as the name suggests, is a broad-based commodity price index. The first chart below begins with the fourth quarter of 2008, during which the financial crisis hit the world full-on (Lehman Brothers failed in October). Both indexes have been rebased to 100 at the beginning of the period.

Source: Dow Jones Indexes.

As we compare the two graphs during this period, we can see no clear relationship between gold and the broader group of commodities. As fear of financial and economic collapse increased, and as authorities across major developed economies responded with huge dollops of fiscal and monetary stimulus, investors began to treat gold as a currency no government can debase, rather than as a precious metal with limited industrial applications. It benefited accordingly, appreciating strongly; meanwhile, there is no corresponding trend for commodities, which look stuck within a range.

Putting things in focus
Now, let's focus on the end of that period. Here is the same graph for the year to date. I've again rebased the two indexes to start at 100 at the beginning of the period.

Source: Dow Jones Indexes.

Over this timeframe, the two graphs are a lot more tightly aligned. The chart suggests that gold price movements are now consistent with those of a broader set of commodities. By extension, the same factors are driving returns, including expectations for global -- and particularly Chinese -- GDP growth. Meanwhile, the notion of gold as a safe haven appears to have lost its appeal with investors.

Gold is no longer an effective hedge
This is consistent with my own observations that gold is no longer functioning as an effective hedge in the face of market upheaval. For example, the metal achieved its all-time high in early September last year -- well before the European crisis hit its (most recent) nadir in the fourth quarter. Since then, I have seen gold retreat with other risk assets on "risk off" days, giving the lie to its safe-haven status.

If gold were still trading as an alternative, "hard" currency, we should expect prices to be at or near fresh highs right now, given the level of fear related to the eurozone crisis. Indeed, if we look at other perceived safe-haven assets -- whether they be the Swiss Franc, German Bunds, Japanese government bonds, U.K. gilts, or U.S. Treasuries -- all are at or near historic levels. The SPDR Gold Shares ETF (NYSE: GLD  ) , meanwhile, has declined by nearly a fifth since its Sept. 6 intraday high.

Not a currency, just a metal (albeit a precious one)
Last month and at the end of 2011, it was reported that the gold chart was in the throes of a "death cross" (which certainly sounds unpleasant), with the 20-day moving average moving below the 200-day average. I don't normally put much stock in technical analysis, but many people who trade gold do (there are no fundamentals to go on, after all). I'm told a death cross is a bad omen. Perhaps it is utter nonsense, but it can't help sentiment. Either way, investors who own gold should be aware that it is now trading like a metal, rather than as a safe-haven currency. If exposure to the commodities sector is what you're after, you'll want to look at this free Motley Fool report: "The Only Energy Stock You'll Ever Need."

Fool contributor Alex Dumortier holds no position in any company mentioned. Click here to see his holdings and a short bio. You can follow him on Twitter. The Motley Fool has a disclosure policy. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. Try any of our Foolish newsletter services free for 30 days.


Read/Post Comments (23) | Recommend This Article (12)

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  • Report this Comment On May 30, 2012, at 12:34 PM, TopAustrianFool wrote:

    "Gold is no longer an effective hedge"

    As long as you have fiat money, gold will be useful to preserve wealth. Its not a good investment for growing wealth.

    The Fed always allows diflation during hard times like the current ones, so the dollar won't crash for a very long time. Nevertheless, gold, silver, copper, or even diamonds will certainly give you temporary "cash-flow" during bank runs.

  • Report this Comment On May 30, 2012, at 12:42 PM, dragonLZ wrote:

    What a timing for this article.

    It's a risk-on day (Dow down 160 points or 1.3%, Vix up 10%), and Gold is up almost 1% ($14).

    Oil, another widely followed commodity, down 3.4%.

    Not really supporting your theory right now...(but we'll see what happens tomorrow)...

  • Report this Comment On May 30, 2012, at 12:44 PM, EGTalbot wrote:

    Okay, a couple of suggestions here:

    1.How do a couple of commodities charts show that gold has lost its status as an effective hedge? What we'd need to see is gold versus what it's supposed to be hedging.

    2.The death cross. Go check the last time before this year that gold had a death cross. Then look at the price of gold a year after that. I could tell you the answer, but I wouldn't expect you to take my word for it, so look it up.

    All that said, my gut is that gold trading HAS changed in the past 6-8 months. For speculators or people looking at trades of less than a year, being long gold carries more risk than it has in 4 years. I'd even agree that stubbornly claiming "gold is a currency," and betting everything on that is probably not smart. But gold has been money (and a safe haven) for so many centuries that it would seem pretty smart to make a long term bet commensurate with your opinion about how badly the world's financial system and currencies are going to suffer in the next 2-20 years

  • Report this Comment On May 30, 2012, at 12:47 PM, rhealth wrote:

    Gold and Silver follow cycles that have nothing to do with the stock indices, so at times you will see it go up as stocks go down, other times both will go up or down together. In the middle ages people thought rats were generated from piles of rags because that's where they always saw them, today no one believes that.

    If you want to know gold or silver, learn it's cycles.

  • Report this Comment On May 30, 2012, at 12:50 PM, TMFMorgan wrote:

    <<As long as you have fiat money, gold will be useful to preserve wealth.>>

    It's not that clear. There have been periods of high inflation when gold loses substantial value in both real and nominal terms for years on end.

  • Report this Comment On May 30, 2012, at 1:38 PM, TopAustrianFool wrote:

    "It's not that clear. There have been periods of high inflation when gold loses substantial value in both real and nominal terms for years on end."

    I don't know how you define inflation, but gold, doesn't loose substantial value. How do you define the value of gold? In fiat currency terms? If you do, then it is the fiat currency the one fluctuating in value, not gold.

    The Fed tries to manage the value of the dollar. It constantly misjudges the economy and makes mistakes. When the mistakes are apparent you get inflation and deflation. Gold's value is pretty much the same, it changes slowly. The problem you are having is that you are measuring gold's value with a standard ruler (fiat currency) which the Fed is constantly redefining.

  • Report this Comment On May 30, 2012, at 2:07 PM, talan123 wrote:

    Thank you for a reasoned and well thought out arguement.

    At this point with all the passion running around it, I call it a fiat metal. It's value is no longer connected to what it's use for and to some people it has become a currency. It's value is no longer tied to its uses but rather the belief it is worth more. If you look at over the last year then the price has gone down while inflation has continued meaning it has become worth even less.

    Of course a much scarier outcome would be that gold is still a good investment but rather we are in a cycle of deflation.

  • Report this Comment On May 30, 2012, at 2:12 PM, portefeuille wrote:

    you (and dragonlz) mean "risk off", not "risk on".

    risk on <-> equities rise (especially "high beta ones").

    http://en.wikipedia.org/wiki/User:Rzyzkc/Risk_on_Risk_off

  • Report this Comment On May 30, 2012, at 2:22 PM, portefeuille wrote:
  • Report this Comment On May 30, 2012, at 2:33 PM, TopAustrianFool wrote:

    "It's value is no longer tied to its uses but rather the belief it is worth more. If you look at over the last year then the price has gone down while inflation has continued meaning it has become worth even less."

    How can it be fiat metal? Fiat means that its face value is lower than its intrinsic value. Like in money paper. The face value of a dollar is much higher than the paper is printed on. Not with gold.

    "Of course a much scarier outcome would be that gold is still a good investment but rather we are in a cycle of deflation."

    The Fed is producing a yearly cycle of inflation and deflation. And now we are on a small deflationary cycle. The Fed started this cycle when it allowed interest rates to float freely back in February and March.

    In August, the Fed will reduce interest rates artificially again and the stock market will start increasing a bit by the end of the year. Its all inflation, not much else.

  • Report this Comment On May 30, 2012, at 2:35 PM, TMFAleph1 wrote:

    @portefeuille

    You're correct -- I will request a correction at once.

  • Report this Comment On May 30, 2012, at 3:21 PM, whatevmatil wrote:

    Here is a little gem from Einhorn's 5/29/12 letter: "The debate around currencies, cash, and cash equivalents continues. Over the last few years, we have come to doubt whether cash will serve as a good store of value. If you wrapped up all the $100 bills in circulation, it would form a cube about 74 feet per side. If you stacked the money seven feet high, you could store it in a warehouse roughly the size of a football field. The value of all that cash would be about a trillion dollars. In a hundred years, that money will have produced nothing. In a thousand years, it is likely that the cash will either be worthless or worth very little. It will not pay you interest or dividends and it won’t grow earnings, though you could burn it for heat. You’d have to pay someone to guard it. You could fondle the money. Alternatively, you could take every U.S. note in circulation, lay them end to end, and cover the entire 116 square miles of Omaha, Nebraska. Of course, if you managed to assemble all that money into your own private stash, the Federal Reserve could simply order more to be printed for the rest of us."

    Gold (commodities) is/are a safe haven from central bank printing and fiat money problems. Recently it has been correlated with other asset classes in risk on risk off days, but recall it's performace vs. the S&P500 last year when the S&P put the USA on credit watch. That is what gold is a hedge against.

  • Report this Comment On May 30, 2012, at 4:54 PM, leohaas wrote:

    You are probably right, although I don't know what will happen in the next financial crisis. And some will argue that such a crisis is in the making...

    Just one thing: if you think technical analysis is hogwash, then don't use it to make your argument. Either you believe that the 'death cross' has real meaning in which case you can use it as an argument, or you think it belongs in the land of the unicorn in which case you cannot use it to make your argument.

  • Report this Comment On May 30, 2012, at 5:52 PM, TMFAleph1 wrote:

    <<Just one thing: if you think technical analysis is hogwash, then don't use it to make your argument. Either you believe that the 'death cross' has real meaning in which case you can use it as an argument, or you think it belongs in the land of the unicorn in which case you cannot use it to make your argument.>>

    This isn't Newtonian physics we are discussing. Whether or not *I* believe in technical analysis doesn't matter; what matters is whether a sufficient number of market participants believe in it. Beyond a certain threshold, the framework creates its own reality. In the gold market, specifically, I believe the proportion of investors who believe in technical analysis is very high.

  • Report this Comment On May 30, 2012, at 9:10 PM, reallypeacedoff wrote:

    With the indices down so much as well as oil, and USD getting a large bid, I would imagine the jump for GLD has something to do with an ECB announcement coming within the next 2 weeks. Stimulus anyone? It won't be QE3, as the US will save that for the end of summer as their last can down the road...

  • Report this Comment On May 30, 2012, at 9:53 PM, awallejr wrote:

    " In the gold market, specifically, I believe the proportion of investors who believe in technical analysis is very high."

    Well unless you have taken a poll (which you haven't), this is mere supposition on your part. I hold a portion of my assets in gold and it has nothing to do with technical analysis and I submit most people hold gold without any such techinical visions.

    And while your first chart which covers a longer period of time shows no corresponding correlation between gold and commodities, you decide to take a measly 5 month period to base your arguments.

    Let's ignore the fact that gold is at one of its highest levels in history. Not it's highest level, that was a year ago, but compare it to EVERY OTHER YEAR it is higher now.

    Based on what I submit is shallow analysis your conclusion is nothing more than a prognostication. Things correct. The stock market has gone up almost 5 straight months and now (fittingly in May) it is correcting. It has very little to do with Europe. The volatility might. But it is a correction nonethesless in my prognostication.

    Now if you just want to suggest a short term trade, well it is anyone's guess in the end.

  • Report this Comment On May 30, 2012, at 10:01 PM, TheCommonTulip wrote:

    I disagree. This article could just as easily be titled "cash-it's just paper folks". Anything that's valued as a currency (of sorts) only has the value that people assign to it. While I know that you can't go into a store and buy soap with gold I think gold has a pretty strong historical track record as a safe haven. Just my personal two cents though.

  • Report this Comment On May 31, 2012, at 12:52 AM, gcp3rd wrote:

    To whatevmatil, your post supports the opposite of your opinion and Einhorn appears to have found some inspiration from elsewhere for his letter, but the analogy works for paper money AND gold!

    From Berkshire Hathaway's opening letter (for god's sake read it if you haven't) for the 2011 annual report, dated 2/25/12:

    "Today the world’s gold stock is about 170,000 metric tons. If all of this gold were melded together, it would form a cube of about 68 feet per side. (Picture it fitting comfortably within a baseball infield.) At $1,750 per ounce – gold’s price as I write this – its value would be $9.6 trillion. Call this cube pile A.

    Let’s now create a pile B costing an equal amount. For that, we could buy all U.S. cropland (400

    million acres with output of about $200 billion annually), plus 16 Exxon Mobils (the world’s most

    profitable company, one earning more than $40 billion annually). After these purchases, we would

    have about $1 trillion left over for walking-around money (no sense feeling strapped after this buying binge). Can you imagine an investor with $9.6 trillion selecting pile A over pile B?

    Beyond the staggering valuation given the existing stock of gold, current prices make today’s annual

    production of gold command about $160 billion. Buyers – whether jewelry and industrial users,

    frightened individuals, or speculators – must continually absorb this additional supply to merely

    maintain an equilibrium at present prices.

    A century from now the 400 million acres of farmland will have produced staggering amounts of corn, wheat, cotton, and other crops – and will continue to produce that valuable bounty, whatever the currency may be. Exxon Mobil will probably have delivered trillions of dollars in dividends to its owners and will also hold assets worth many more trillions (and, remember, you get 16 Exxons).

    The 170,000 tons of gold will be unchanged in size and still incapable of producing anything. You can fondle the cube, but it will not respond."

  • Report this Comment On May 31, 2012, at 3:26 AM, Crazylegs52 wrote:

    As a new Fool, I am always interested in the discussions surrounding Gold. Everyone seems to be so passionate about whether it is a sound investment, or a waste of time.

    I am not an economist, or financial analyst. I am a simple guy who is learning. BUT, I view Gold simply as a hedge against other investments. I do not view it as a traditional investment in comparison to a company or buying land. There are always arguments as to whether a particular company yo have chosen has a future, or real estate has value.

    If someone is buying ONLY Gold, and nothing else, they are not making sound financial decisions. However, if it is a portion of your portolio that you intend to hold long term, such as the Fool recommends, I can only agree, by historical standards, Gold does very well, doesn't it?

    The good and bad of Gold is that there is no CEO, no Board, no product to evaluate. It is all based on the mood of the people it would seem. But, Gold has always been WANTED. That appears to be its defining value.

  • Report this Comment On May 31, 2012, at 8:44 AM, mapbc wrote:

    "Gold has never been worth zero"

    The infomercials tell me so.

  • Report this Comment On May 31, 2012, at 10:46 AM, TMFAleph1 wrote:

    <<However, if it is a portion of your portolio that you intend to hold long term, such as the Fool recommends, I can only agree, by historical standards, Gold does very well, doesn't it?>>

    No, it doesn't. Gold maintains its purchasing power over the very, very long term, while exposing its owner to substantial volatility over anything less than multi-decade periods.

  • Report this Comment On June 01, 2012, at 2:42 PM, whatevmatil wrote:

    @gcp3rd i read the buffet letter when it came out. Einhorn is poking fun at the concept. You are right, the analogy works for money AND gold. Only difference is you can print more money (QE). You can't print gold.

    Gold is not the answer to all risks. It is the answer to the fiat debasement, currency risk.

  • Report this Comment On June 29, 2012, at 7:30 AM, TempoAllegro wrote:

    It does not matter whether we call gold a (precious) metal, an inflation hedge, or even think of it as currency. The fact is, the price of gold is not easily correlated to other asset classes, and that is a good thing in my opinion. So I say buy some - or some other precious metal like silver, which has more industrial and modern uses.

    While I would not go putting a big chunk of one's net worth into this space, to totally ignore it would be equally silly IMHO. So for me, I am considering keeping a little SLV plus a dividend-providing ETF of junior gold miners - GDXJ looks good - in my portfolio as a different kind of asset class that looks especially prudent at the moment.

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