The best way to profit from any rebound in the gold price

Gold is universally loathed at the moment

2013 was a dire year for gold. It started the year at around $1,700 an ounce; by the end of June it had plunged to $1,200; after a late summer rally, it ended the year just a little above its low.

If you believe the City, worse is to come. Moody’s is the latest firm to trash the metal, setting a price target of $1,100. Goldman is even more pessimistic, forecasting a drop to $1,050.

Now, we’re happy to hang on to some gold as portfolio insurance. It’s a great diversifier for your portfolio if things turn really bad. And if things keep improving and gold keeps going down – well, the rest of your portfolio is doing well. That’s the point of diversification.

That said, gold is so widely loathed at the moment that we can see various reasons why it might do better than most people think this year. And if that’s the case, any rebound could be very good for the one asset class that is even more hated than gold – gold miners.

The big name investors have been dumping gold

Investor behaviour moves in cycles, swinging from bullish to bearish and back again. One sign that it has hit one peak or another is when ‘capitulation’ occurs.

This is where investors – particularly high profile ones – who have been moving in the opposite direction to the market throw in the towel. The bears turn bullish, and vice versa. However, they usually change course at just the wrong moment – because when the last bull turns bearish, there’s no one left to sell the market.

For the gold market, the most high-profile buyer has probably been hedge fund titan John Paulson. In 2010 he launched a gold fund. Last year its value fell nearly two-thirds, from around $1bn to $370m.

Not only has Paulson ‘rebranded’ the fund (to be fair to him, his other funds were extremely successful last year), he has also advised investors not to put any more money into it. He also slashed his other gold holdings in 2013.

He’s not the only one. George Soros and Daniel Loeb (who runs the $14bn Third Point Hedge Fund) have also sold their holdings in the main gold exchange-traded fund. These moves at least suggest that we have seen some sort of ‘capitulation’.


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The return of the eurozone crisis

One of the reasons that gold did so badly last year is that it has been seen as a ‘safe haven’ against either a euro breakup or mass money printing by the European Central Bank (ECB).

But the ECB’s promise 18 months ago, that it will do everything possible to save the euro, seems to have convinced markets that everything will be OK. Interest rates for the high-debt countries have fallen, and the euro has actually gone up in value – even although the ECB hasn’t actually done anything much.

However, this state of affairs may not last. Weak lending and monetary data suggest that there is a real risk of deflation – inflation is at a multi-year low. That’s enough to have any central banker feeling jittery.

Meanwhile, after several years of austerity and recession, anti-euro sentiment is reaching a critical mass. In France, the far-right Marine Le Pen has experienced a surge in popularity. In Italy, the disgraced Silvio Berlusconi is re-emerging as an anti-Brussels populist.

And, as Matthew Lynn recently pointed out, the fact that Greece is now running a trade surplus makes it easier for the stricken country to bring back the drachma (or at least threaten to). While a breakup isn’t the most likely scenario, the ECB could be forced to turn on the printing presses, which would push up the value of gold.

Asian consumers might get the go ahead to buy more gold

Another big driver behind the rise in gold over the past decade has been the surge in demand from consumers in India and China. These increasingly affluent buyers have been looking for a reliable home for their savings. The falling gold price has boosted Chinese sales, estimated to be up by 15% over the last year.

Demand in India, meanwhile, was so strong last year that the government was forced to outline punitive import tariffs and export restrictions, because of its impact on the trade balance.

Before the measures, India’s gold imports were only second to its oil imports. But while the measures reduced official imports, they also led to a huge amount of smuggling. It also created a backlash. And that suggests the restrictions will be lifted soon as India’s economy improves. That’s likely to provide a big boost to global demand for gold.

Gold miners are very cheap

Rather than buying gold, if you think the price is going to rebound, you could look at the mining sector. Falling prices and rising costs have hammered gold mining shares. As a result, many trade at very low multiples of current earnings. While some of these low valuations are justified, there are potential bargains out there.

One company that looks very interesting is Medusa Mining (LSE: MML), a gold producer in the Philippines. Unlike most of its rivals, it is a low-cost producer, meaning it should keep turning a profit, even if the gold price falls further. It trades on a price/earnings ratio of 7.3. And it trades at a premium of only 3% to its net assets, compared with the 50-100% premiums of firms such as Ashanti and Randgold.

Medusa is far from the only beaten-down gold mining stock. If you’re interested in the sector, and cherry-picking possible bargains, you should take a look at what my colleague Simon Popple has to say about it.

• Metals and Miners is a regulated product issued by Fleet Street Publications Ltd. Your capital is at risk when you invest in shares, never risk more than you can afford to lose. Past performance and forecasts are not a reliable indicator of future results. Please seek independent financial advice if necessary. Customer services: 0207 633 3600.

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6 Responses

  1. 10/01/2014, Ellen12 wrote

    You are reluctant to be bullish. Is this just because market sentiment has turned against gold. The wider economy carries on going into no mans land, printing, borrowing and suppressing interest rates instead of growing and producing. The rise of bitcoin, if nothing else, really demonstrates the wish for those who would like to have more certainty about currency values than central bank policies would afford them. And China continues to buy gold while it remains the most oversold investment around. I do suspect plenty of manipulation in the gold market by very big players but, even they, need to find the gold to settle their shorts, even if they started out as naked shorts. And I can’t see them doing that by shutting down goldmines.

  2. 10/01/2014, Tyler Durden wrote

    If you want to do well with a strategy then the place you want to be is when sentiment on something tells you it is the last thing you should be buying.

    I will also re-iterate that ETFs mean absolutely nothing. The fact that Soros or anyone else has come out of them has absolutely nothing to do with ‘physical’ gold.

    Goldman or whoever else can forecast the price of an ETF ounce of gold down as far as they like, but once again, it has nothing to do with the physical market. Sooner rather than later that will break away.

  3. 12/01/2014, diversify your gold holding wrote

    I believe in trying to diversify as much as possible and that applies to our gold holdings as well. We are fortunate n living in Asia where nearly every street has a gold shop so buy/sell spread is amazingly low (1/2% or less) as opposed to 8010 % with western dealers. Not that we ever will sell unless we need a bit of money for living and our income which is very variable is not enough for odd month or so and then we always buy back gold when income has returned to its more normal average. Weve been buying since 2008/09 crash and unlike most advise we feel 20-25% in gold is more appropriate given in our view the very high risk of a huge financial meltdown. Most of our other assets are in property both in UK and in asia and yields around 6-7% net. We sold all our stocks (except gold and silver mining) around 9 months ago but do not regret one bit missing rise since then feeling much safer with gold and silver. SO we hold around 60% gold and 40% silver. We use bullion vault for most of silver and use gold silver for some stored in Hong Kong. We also have some gold stored in UK in a very safe place as well as a little physical stored in Singapore. 35% of our holding we keep as physical at a safe deposit box here in Asia. So my advise is diversify your gold and silver as much as possible if you can just in case. Again although weve lost around 50% on our gold mining shares we are in it for long term and will when/if we have more funds but more gold and silver mining shares. If were wrong and say gold drops another 25% then well have lost 7% or so of our assets. So what it would mean our main income from property would be stable. I consider 10% maximum advise as useless since say your other assets drop 50% and gold doubles your still in loss by around 35% while using our 25-30% allocation then under same scenario it evens out almost exactly and if as I except things get really bad then gold will not only protect but increase your real wealth.

    • 12/01/2014, Ellen12 wrote

      Where abouts in Asia are you?

  4. 27/01/2014, pc249 wrote

    Money week is not reporting the blatant manipulation of the Gold and Silver markets. Additionally, a currency reset appears to be imminent and is expected on 4th March 2014. Thereafter there will be a Bull Market in Gold and Silver that surpasses anything experienced before;

    Precious Metals Manipulation Worse Than Libor Scandal, German Regulator Says
    http://www.zerohedge.com/news/2014-01-16/precious-metals-manipulation-worse-libor-german-regulator-says

    http://www.coinweek.com/bullion-report/fallout-already-starting-investigations-london-gold-silver-market-price-manipulations/

    As ever

    Phil

  5. 03/02/2014, Rickthe1 wrote

    Phil is absolutely correct. Manipulation is rife on the instructions of the US government with other Western collusion. China is buying all it can, India has had to impose stringent restrictions on imports and third world countries are taking back their gold holdings from the West. Demand from Joe Public for gold and silver coins has never been greater. Jump on the bandwagon now, before it is too late.

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