After recording its 12th consecutive annual gain last year, many prognosticators figured gold would keep rising in 2013. Not only did gold have price momentum, but fundamental demand was up and monetary experiments by global central bankers were undermining the stability of fiat currencies.
Despite all of the bullish underpinnings, physical bullion and gold ETPs, like the SPDR Gold Shares (GLD), have defied bullish expectations by declining around 16% during the first eight months of the year. Most commodities are still down in price from their 2008 peak. Will precious metals revisit new market lows? And is a reversal back to $1,000 per oz. for gold bullion a far-fetched scenario?
Bubbles and History
Price bubbles usually take different paths when they are birthed and formed.
Certain bubbles, like the Dutch Tulip Bulb Mania, were built strictly on speculation. On the other hand, the dot-com bubble was created on the expectation of new, game-changing technologies and productivity. And other bubbles, such as the recent housing frenzy, were built on loose credit and misguided economic policies.
Regardless of the reasons behind their formations, all bubbles have identical endings; a quick reversal and panicked selling that crushes prices. At that point, fear becomes a stronger force than greed, which partly explains why bubbles have the tendency to crash faster and harder.
Gold's most recent bubble has been punctuated by popular reality TV shows about gold mining along with "sell your gold" kiosks showing up in shopping malls across the U.S. Like all bubbles, excessive bullish sentiment foreshadowed gold's eventual fall.
Waning Metrics
During the second quarter, hedge funds and speculators exited their gold positions in bullion ETPs as selling activity accelerated to $18.29 billion from $9.2 billion during the first quarter. The net result was a more than 400 tonne decrease in ETF holdings in the second quarter.
The prospects of improving economic data in theU.S., along with less quantitative easing by the Federal Reserve, have put downward pressure on both gold prices and bullion demand. From Q2 2012 to Q2 2013, net gold demand in all categories fell 23%, led by less demand for investment (down 68%), central banks (down 62%), and technology (down 11%), according to the World Gold Council.
"Gold and silver are still basing and trying to resolve their oversold condition from June. They have not begun a sustainable rally yet and still need to do more work technically before this can occur," said Daryl Montgomery, author of Inflation Investing: A Guide for the 2010s.
Painful Markups
While the merits of owning physical gold are evangelized, the shortcomings are too often overlooked. For instance, the typical markup that bullion dealers charge customers is between 5% to 8% over spot prices and others (we won't mention any names) skim even higher percentages!
The U.S. Mint marks up the price of coins it produces (usually around 3%) to cover the value of the metal along with minting, shipping and other costs. Authorized purchasers who buy from the Mint add their own markup. And if they sell to dealers who sell to the public, another markup gets added. Guess who's at the bottom of the food chain? That's right, physical bullion buyers.
