By: Will Blazejeski
In mid-May, the jewelry departments of Sears and K-Mart announced programs in which their shoppers can mail in spare gold for cash. Already bombarded with “cash for gold” advertisements on the TV and internet, the programs by Sears and K-Mart represent yet another venue for consumers to cash in on “historically high” gold prices.
Alternatively, we’ve seen gold seemingly every day on financial news networks for the past two years now, with some commentators, notably Jim Cramer, saying that it may not be too late to get into gold.
Whether you’re contemplating bringing your grandmother’s engagement ring to Sears or heeding Cramer’s advice and buying gold ETF’s, one must consider the implications of each decision and the factors that affect gold prices. No matter what side of the argument you’re on, it can be agreed upon that the price of gold a year from now remains in the balance.
Pricing
There are many components affecting gold prices, with some playing a larger role than others. Recently, currency debasement and concerns over the stability of the Euro have been the most influential factor in the daily fluctuations of gold pricing. With uncertainty high and investor sentiment changing with every new headline about Greece, Spain and Portugal, gold’s role as a safe haven has grown significantly.
Large investment funds have also held a significant role in the pricing of gold. Legendary investor George Soros tripled his holding in the GLD ETF from 2.5 million to 6.2 million shares in the fourth quarter of 2009 (although he has since sold 500,000 shares.) GLD accounts for over 16% of John Paulson’s Paulson & Co.’s holdings, and in the first quarter of 2010 investment banks Morgan Stanley and Bank of America purchased 1 and 2.3 million shares, respectively.
Central banks have historically been the most influential players with regard to gold pricing. They are the largest buyers and sellers of gold on the market, and have recently become net buyers after having been net sellers for close to 20 years, which can be largely attributed to the central banks of developing countries. China has increased their gold reserves from 600 to 1,054 tons over the past 5 years, and in November the Reserve Bank of India alone purchased 200 tons of gold, increasing their reserves to 6% (still low compared to the U.S., which holds 70% of their reserves in gold, but higher than China and the rest of Asia at only 2% of reserves in gold.) This trend is expected to continue as developing countries are seeking alternatives to the dollar and euro for their reserves.
Overpriced? Underpriced?
It’s important to remember that the uses for gold at its most basic form are very limited. Outside of supply and demand (where, by the way, gold demand must rise only about 1% a year to keep S&D in balance) and the aforementioned factors, gold is primarily influenced by speculation and emotion. This “perceived value” is unique to gold. Money managers’ recent bets on gold are simply statements that in the near term the world economy will remain unstable, leading to higher gold prices as investors look for safe haven investments.
Although it’s clear that there’s a correlation between world events and the pricing of gold, according to Scott Redler, chief analyst of T3Live.com, headline news should not be the sole influence of investors’ decisions. Scott has been very successful with predicting the price movements of gold. He attributes this to not being too involved with all of the hype. “Everyone has been saying it’s an inflation trade, it’s a fear trade, now it’s a sovereign debt trade – then it’s a no-one-wants-paper trade,” he said. “The bottom line is, I look at the charts, I look at how it holds up, I look at the price action, and I don’t try to make it too crazy.”
During gold’s last rally, Redler claims you didn’t have to be an expert in order to see the writing on the wall. This was when gold broke out from a reverse head and shoulders pattern around $990/ounce, and the measured move was to around $1,200/ounce. “I looked at the patterns, and then the pattern ignited,” he said. “It traded well throughout the course of the move and then we sold it at $1200. Then, we looked to get back involved once when we saw a new pattern, which we just saw develop.”
Yesterday, we saw spot gold break its May 12th all-time high, with gold futures wrapping up for the day at $1,254.50/ounce. With a slight pull back today, many analysts are claiming that the ongoing sovereign debt concerns will push the metal higher, while others are citing that the physical demand for gold tends to drop during the summer, which will begin to weigh on gold prices.
Gold has been tradable for two years now and will continue to be for the foreseeable future. The price of gold has been largely driven recently by the irrationalities of investors both large and small. Pay attention to the headlines, but use technical patterns in order to get good entry levels, and don’t be afraid to take profits. Profit off of the irrational emotions of others; that’s the name of the game.
