Gold is now in a bear market – is it time to sell?

With its price now more than 20% below its 2011 peak, gold is now in a bear market. Does this spell the end of the long-term bull run? John Stepek investigates.

It's been a terrible few days for gold.

On Friday, the yellow metal collapsed down through the $1,500 an ounce mark. And in this morning's trading, it fell as far as $1,425 at one point.

Subscribe to MoneyWeek

Become a smarter, better informed investor with MoneyWeek.

The price has now fallen by more than 20% from its September 2011 peak of around $1,920. That means that gold is now in a bear market.

For a while, we've been saying that you should hold around 10% of your portfolio in gold as insurance against a wobbly financial system.

Advertisement - Article continues below

So has gold outlived its usefulness? Is it time to ditch your insurance policy?

I don't think so. Here's why

Are Japanese government bonds behind the collapse in gold?

When gold suffers a brutal collapse, the conspiracy theorists rush out of the woodwork, muttering darkly about "price suppression". Ignore them. It's not good for the blood pressure and it doesn't help matters.

A number of factors have hit gold in recent days. For one, sentiment among investment banks has started turning bearish. Socit Gnrale issued a sell' note on gold recently, while Goldman Sachs went as far as to recommend shorting it. Good timing on their part as ever.

But it's not just gold. Commodities as a whole have been suffering. The oil price has taken a dive over the last couple of sessions. Copper is at an eight-month low. One slightly technical theory, cited by the Zero Hedge website, is that this general plunge is linked to the Japanese government's money-printing plans.

Since the new central bank governor, Helicopter' Haruhiko Kuroda promised to re-inflate the Japanese economy, Japanese government bonds (JGBs) have been on a wild ride.

Advertisement - Article continues below

If Kuroda is true to his word, then the current miniscule yield on JGBs (around 0.6%) is unjustified. It has to rise (and so bond prices have to fall).

At the same time however, if the central bank is planning to snap up JGBs, then why would you sell them? You've got a guaranteed buyer willing to chase prices higher (as has happened in the US and the UK).

So, even as some flee JGBs, others are keen to buy in. And as a result, JGBs have become much more volatile in other words, the price has fluctuated a lot more than normal.

When the price of an asset becomes more volatile, anyone using borrowed money to invest in them, has to put a bigger deposit (also known as margin') down. If you've ever used spread betting, you'll know how this works.

If you haven't, the margin' is there so that if your bet moves into a losing position, the person who loaned you the money to speculate won't be out of pocket. It's just like a bank asking you to put a 20% deposit down on a property. The deposit protects the bank if prices fall.

So, anyone holding JGBs is being asked to put up a bigger margin to do so. That means they need to raise the money from somewhere. That somewhere' includes taking profits on gold and other commodity holdings.

Advertisement - Article continues below

It's a theory at least. And if you're looking for something to explain the last couple of days' sell off, it's one of the more interesting ones.

Gold as a measure of faith

But I think there's a better way to explain gold's recent lacklustre performance.

It's no coincidence that gold has sold off in the wake of Japan's promise to "do what it takes" to revive its deflating economy. But it's not really about the margin calls'. It's about faith in central banks.

We've always seen gold as a form of insurance against financial calamity. At the start of this century, that insurance was cheap, because everyone believed that nothing could go wrong. After all, Alan Greenspan, the Maestro', was in charge of the Federal Reserve, and by extension, global investment markets.

Gold's rise coincided with investors gradually losing faith in the ability of central banks to keep a lid on inflation and the credit bubble. And when the financial system froze up in 2008, gold was among the first assets to bounce back.

Advertisement - Article continues below

But since then, investors have been well-trained by the Federal Reserve, and to a lesser extent, the Bank of England. When a central bank prints money, the price of stocks goes up. You don't need to worry about anything else. Just buy shares and the central banks will take care of the rest.

So what's really hurt gold is the return of faith in central bankers. Think about it. When gold hit a peak in September 2011, that was just before Mario Draghi took charge at the European Central Bank.

He was taking over from Jean-Claude Trichet, a man who had entirely lost the confidence of investors. Since then, Draghi has promised to "do what it takes" to save the euro. He's seen as a safe, market-friendly pair of hands.

And now even the Bank of Japan has seen the light. So why would you hold on to gold? The central bankers have it covered. Everything's going to be fine. So get out of boring, old gold and go buy some riskier assets.

Why you should still be insuring against financial disaster

We've been saying for some time that you should treat gold as insurance, and have no more than 10% of your portfolio invested in the metal. So is it still worth hanging on to this insurance?

I can see gold going lower from here. I'm no technical analyst, but you don't have to be to look at the gold price chart and say: "That's ugly."

Advertisement - Article continues below

However, the answer has to be "yes I'm holding on to gold". Here's why.

I'm happy to have money invested in equity markets just now. In terms of exposure to general markets, I'd hold Japanese and eurozone funds or trackers. I think they're cheap, and they'll keep going up.

In developed markets like the US and UK, I feel the overall indices are expensive (in the US) or imbalanced (the UK). I'd prefer a portfolio of individual stocks that pay an income and give exposure to the US dollar.

In any case, I think it's a good idea to have your money invested in markets rather than sitting under your bed.

But would I feel comfortable having a portfolio without any gold in it? No.

Central bankers might have won back the confidence of investors for now. The central bank put' - where investors bet that central banks will bail them out, no matter what is being wedged back in place. Central banks may even have won the war on deflation.

Advertisement - Article continues below

But make no mistake, current monetary conditions are unprecedented. Interest rates have never been this low. The Bank of England owns about a third of all outstanding UK government debt. The Federal Reserve holds about 10% of US debt.

How does all of this unwind? I don't know. No one does. But I can imagine it might get messy. Just look at the JGB market: despite Bank of Japan assurances, it's acting like a bucking bronco just now, which just shows that central banks can't control everything.

In short, I'm happy to ride markets higher via the stocks and indices we've been endlessly suggesting over the past few years. But I also want to be holding some gold, just to be on the safe side. We'll be looking at the yellow metal in more detail in the next issue of MoneyWeek magazine, out on Friday.

Follow John on Twitter || Google+ John Stepek

This article is taken from the free investment email Money Morning. Sign up to Money Morning here .

Our recommended articles for today

This is one of my favourite funds

Utility stocks offer a great way to protect your wealth from the ravages of inflation. That's why you should consider adding this great fund to your portfolio, says Bengt Saelensminde.

Advertisement - Article continues below

Prepare for Japan's coming shares boom

SUBSCRIBERS ONLYA radical new approach to quantitative easing will give Japanese stocks a big boost, says James Ferguson. Here, he explains why, and tips the best Japanese shares to add to your portfolio.




Don’t panic about Iran – but don’t sell your gold either

Markets have reacted calmly to the tension between the US and Iran. But don’t get too complacent. It’s still a good idea to hold on to some gold as in…
9 Jan 2020

Here’s how gold could rise above $7,000 an ounce

That the gold price could hit $7,000 an ounce is a logical and plausible possibility, says Charlie Morris. Here, he explains how it could get there.
30 Dec 2019

Gold is in a bull market – and it could have much further to go

Many investors forget that gold is still the best-performing asset of this century, says Charlie Morris. It could also have much further to go.
27 Dec 2019

All the gold in China: money and power goes east

China has far more gold than official figures suggest – as much as America, in fact. He who owns the gold makes the rules, says Dominic Frisby.
15 Nov 2019

Most Popular


Will coronavirus kill off the bull market?

It seems clear now the coronavirus will at some point go global. And when it does, will it bring down the stockmarket’s bull market? John Stepek looks…
27 Feb 2020

Gold, coronavirus, and the high cost of face masks in northern Italy

The price of gold is spiking – as it always does in a global panic. But this bull market predates the coronavirus epidemic, says Dominic Frisby, and w…
26 Feb 2020
Pension tax

Why it makes sense to scrap higher-rate pensions tax relief

The point of pensions tax relief is to keep you out of the means-tested benefits system. The current system is ridiculously generous, says Merryn Some…
24 Feb 2020

The rare earth metal that won't be a secret for long

SPONSORED CONTENT – You can’t keep a good thing hidden forever; now is the time to consider Pensana Rare Earths and the rare earth metals NdPr.
31 Jan 2020