Why gold could stage a big recovery

It’s been a very interesting year for gold so far. We’ve seen the price of the yellow metal fall hard, only to recover to around $1,600 in the wake of the Cyprus debacle.

In fact, gold is being pulled in two directions right now.

On the one side, you’ve seen large hedge funds and City players dumping gold during the first quarter of 2013. And on the other, we have seen private investors and emerging-market central banks continue to accelerate their purchases of physical gold.

In fact, there’s a massive dichotomy in the market today. This is important, and for anyone with an interest in gold, it’s definitely worth considering its implications. In today’s issue of The Right Side, I’d like to explain why I’m definitely on the side of the gold buyers.

Don’t worry about the speculators

Towards the end of last year, Goldman Sachs issued a research note cutting its 2013 gold target from $1,940 to $1,800. Though the valuation was above the prevailing price, for many of the well-heeled speculators, the Goldman call meant one thing – the metal’s blistering run was set to draw to a close.

And so gold took a fall. Not only were exchange-traded fund (ETF) holdings slashed, but on the futures exchanges (paper gambling on commodities prices), long positions were cut and short positions increased. The price of the metal dropped all the way down to the critical $1,520 mark.

So, why wasn’t I worried about my gold?

Because this is the nature of speculation. Nothing moves in a straight line – be it up or down. And as far as broker research goes, you’ll always find plenty of differing opinions. So, you must always be wary of these types of broker reports.

The guys in their ivory towers are paid to write something – sometimes they’re right, sometimes wrong. And don’t think that they won’t change their minds either… it’s funny how their so-called ‘target price’ always seems to follow the market price.

The point is, these banks and brokers want to generate short-term speculation. That’s how they keep the money flowing and earn their commission.

But for long-term gold buyers – be they private investors or large central banks – speculation isn’t generally the large driver of gold buying. For the central banks, it’s somewhere safe to invest reserves. While for many individuals, gold is an insurance policy.

That’s why they are still buying. So far this year, the US Mint has reported sales of 265,000 oz of gold coins. That’s up on 210,000 oz last year. In fact this year’s March sales (just reported) were up an impressive 50% on last year!

The central banks play their cards a bit closer to their chest. We won’t see figures for quite some time. But there’s plenty of evidence that the emerging-market central banks continue to accumulate gold.

Why the pros aren’t buying for their clients anymore

In many ways, gold investing is anathema to the City pros and institutions. Think about it… gold represents a desire to extricate yourself from the risk of the financial system.

There are two elements to this risk. First the way inflation can batter paper investments. And secondly, there’s the risk of an outright collapse of the financial system.

While a fund manager may be pro-gold as an inflation hedge, he’s much less likely to pump client accounts up with gold to protect against financial collapse. That’s surely more than his job’s worth. It’s a lose-lose outcome – even if his insurance pays off, he’s likely to be out of a job.

The public are therefore left to their own devices when it comes to financial insurance. And as the long, slow grind down of the system collapse plays out, more and more private individuals start to see what’s happening. Insurance policy sales are increasing… private gold sales are up! 

But that doesn’t explain why the City masters have been dumping gold. It’s almost as if they’re no longer concerned about inflation…

There is no end in sight for money printing

At the end of last year, there was another critical announcement for gold by an influential US bank. This time it was the US Federal Reserve. Ben Bernanke and his team were keen to peddle the idea that the controversial policy of money printing was on its way out. That we may even soon see higher interest rates… wow!

At the same time rumours began to circulate that Europe too would take a harder line on quantitative easing (QE). Though Mario Draghi had previously indicated that he’d do whatever it took to save the southern states and their floundering banks, many were unhappy. Rumours that the northern zone wanted less money printing (bail-outs) and more bail-ins from depositors and bank bondholders have been growing. And by gum, to judge by the response to Cyprus’s woes, the speculators were bang on!

This new policy of making bondholders and depositors share the pain of banking reform is an act of destroying money – it’s deflationary!

So are the speculators right? Is this the end of the inflation-induced great gold bull run?

Not to my mind it isn’t. For starters, Ben Bernanke has already made an about turn. He recently defended the Fed’s stance on QE – indeed signalling what was already obvious – there is no end in sight for QE.

And as for the Europeans… the latest bail-out of Cyprus still requires €10bn to be magicked out of Central European Bank coffers.

But most importantly, the new chapter on bank bail-outs has surely served to further destroy faith in money… faith that money is safe in a bank account. Deflation or not – that could be very bullish for gold.

Overall, long-term gold investors shouldn’t be discouraged by today’s divergence in the gold market. Yes, it’s true that many City pros and hedge funds have dumped – even gone short gold. But those guys are short-termers. The resilience of the gold price has been down to an increasing appetite from the long-term holders. The stronger hands, if you like.

In my opinion, recent weakness in the gold price has been a good time to add to financial life assurance policies. If the speculators realise they’ve been on the wrong side of the market this year, we could see some very positive moves for the gold price as they change tack. That’s why I’m sticking with gold.

I think that it’s sensible to hold 5-10% of your savings in physical gold as insurance. And you know my feelings on gold miners.

• This article is taken from the free investment email The Right side. Sign up to The Right Side here.

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