Investing In Gold - Why The Gold Price Has Fallen

We had a good response to yesterday’s piece on gold. One reader wrote in:

‘Gold clearly seems to be moving contrary to the direction that received wisdom would suggest as "normal" given the calamitous economic situation the world finds itself in. So what is providing the downward pressure and what might cause it to reverse?’

To answer this, let’s start by looking at the mechanics of making money from gold. For simplicity, I’m going to assume you just buy physical gold. Your profit or loss depends solely on what happens to the gold price between the time you buy and the time you sell.

By buying gold you are, in effect, buying in the belief that in future, more people will buy it than will sell it. This is true of making a gain on any exchange traded asset. The tricky part is working out whether or not said asset will be more attractive in future than it is today.

That’s the tricky part with buying a share too. But with a share, you tend to have a bit more to go on. For a start, you can undertake fundamental analysis. You can look at balance sheets, earnings forecasts.

You can hazard a guess at what profits might be in the future, and what that will mean for the share price (after all, as the name suggests, a share is your entitlement to share in a company’s fortunes. Higher profits, for example, could translate into higher dividends, attracting more investment in the shares and pushing up their price).

Of course, fundamentals are not the only factor that affect share prices. But we look at them because we know everyone else is. If our view about what they tell us turns out to be right — and others agree with us after we’ve bought in — then, other things equal, we make a profit.

Let’s now contrast this with gold. Gold does not pay a dividend. Gold does not issue statements to the stock exchange, or publish annual results. Of course, gold does have its own fundamentals. We have the physical users of gold on the demand side and the gold miners on the supply side. Studying these can give you clues about where the price is going in the long run.

The trouble is, the gold price is heavily affected by investment demand, as opposed to physical demand (from, say, jewellers). And investors tend to look less at gold’s fundamentals and more at macroeconomic and monetary factors. This holds the key to understanding the recent movements in the price of gold.

For much of this year the gold price has appeared to be inversely related to the perceived fate of the US economy (the key word in the sentence is ‘perceived’). This is hardly surprising since gold, like most commodities, is priced in dollars.

For the first few months of 2008, the US was — according to world opinion — Economic Disaster Zone Number One. The outlook for the dollar was calamitous. Gold, meanwhile, soared, smashing through the $1,000 mark.

But as spring moved into summer, doubts about other economies grew louder. Global investors cottoned onto the fact that the economic hardship would not be confined to the US. Britain and the eurozone looked, to some eyes, even more shaky than America. A bit later and it became official that Britain’s economy had stalled, while the eurozone’s had gone into reverse.

Meanwhile, earlier dollar weakness was causing a mini export boom in the States. New economic data were not as bad as many had feared. The perception shifted — perhaps the dollar wasn’t all that bad... and other currencies not all that good... As a result, one of the earlier upwards drivers of the gold price — the perception that it was a crucial hedge against the doomed dollar — was weakened. I believe this has played a part in why gold has been falling. However, as I’ve written before, I do not believe the long run outlook for the greenback is strong.

There are, of course, other factors in play. As Garry White noted yesterday, the falling oil price has played a part. There will also be indirect causes behind recent weakness — such as investors selling gold to cover losses from other investments.

The broad Fleet Street consensus, though, is that gold’s current weakness is temporary.

For more on this read our mining specialists Erin and Isabel on why the tide will turn for gold.

Lehman Brothers: Bear Stearns 2?

Non-controversial prediction of the week: the bigwigs at the Fed will make another Sunday announcement à la Bear Stearns. Barclays and Bank of America are in the frame as potential victims, sorry, buyers of Lehman. But they’ll probably want some kind of Fed guarantee...

The Fed is involved in a game of tiggy (you may know it as ‘tag’) with the US Treasury. Last week it was the Treasury who stepped in to rescue Fannie and Freddie. In doing so they ‘tagged’ the Fed, whose turn it is now to get out the mop and clean up the latest mess.

So on Monday morning we could be waking up to the details of yet another taxpayer-backed mercy mission...

Time for the May sellers to come back?

Doncaster Racecourse will tomorrow host the St Leger, one of the most famous races in the calendar.

So it’s time to take stock of one of investment’s most well known adages: Sell in May and go away... don’t come back ‘til St Leger’s Day.

Did this turn out to be good advice?

As Theo Casey wrote back in May:

If the market is going to fall this summer, which it probably will:

Blame the deteriorating property market;
Blame the deleveraging investment banks;
Blame the volatile debt markets;
Blame the stingy UK consumer;
Or blame HM Revenue & Customs' ill-conceived proposals.

But leave St Leger out of it.

Today’ Theo revisits this, to see if tomorrow’s horse race means it’s a good time to invest in shares again... and if not, when will be?

This company could be invaluable to China

There’s just time to tell you about a new report that’s coming out next week. I only got a draft copy this morning, and haven’t had a chance to study it properly.

So I’m afraid the details are a little sketchy for now. But what I have read is exciting. The report relates to a "Company X", which could turn out to be the biggest profit play on the boom in China.

The report describes this as "one of those rare investment situations that simply don’t occur that often".

Like I say, I don’t have many details right now. But I’ll have more for you next week...

Until tomorrow

Ben Traynor

Editor

PS Remember, we’re in France next week (assuming the Channel Tunnel re-opens or we get some flights booked!) so FSD may be interrupted. I hope to know more on Monday

Selected articles:

Theo Casey on St Leger’s day investing

Manraaj Singh on how Asia’s battered markets could open up a massive profit opportunity

The Daily Reckoning — Boys, Girls and Lehman Bros: they’re all at it!

Boys do it. Girls do it. Airlines do it. Even towns, bars, and banks do it.

Lehman Bros. looks like it might do it.

"Lehman Races to Find a Buyer," says the Wall Street Journal. If it doesn’t find one it will have to do it.

But can our nation do it?

You can read the Daily Reckoning in full here.

P.S. If you enjoyed this article you can find out more about our free email, The Right Side by clicking here.

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Investing In Gold - Why The Gold Price Has Fallen

Why Gold's Weakness Is Temporary