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Stay the Course As Mixed Signals Move Markets

Monday July 01, 2013 12:42

Traders stampeded out of gold, emerging markets and bonds this month, setting record monthly outflows in June. Ever since the Federal Reserve hinted in May that signs of a stronger economy could allow for a slowdown of stimulus, markets have protested the news.

Traders Stampede to Cash
Gold has been hit hard by the tapering talk and resultant rising interest rates and liquidity drain, falling below $1,200 last week for the first time since August 2010. We’re also seeing India, the world’s biggest gold buyer, trying to stifle gold demand. As the government seeks to reduce its record current account deficit, it has hiked import tariffs on gold to 8 percent and introduced new constraints on rural lending against gold jewelry and coins.

Other factors fueling the liquidation were the raising of margin requirements on gold by the CME Group, the largest operator of futures exchanges in the U.S., and global liquidity concerns in the U.S. and China. When the country with the largest GDP in the world and the country with the largest population on earth have liquidity concerns, traders run from stocks, bonds and gold and head to cash. Even though gold traders have pulled out of their financial investments, there has been a surge in physical gold buying and central bankers have maintained their positions.

We maintain that gold is in extremely oversold territory and mathematically due for a reversal toward the mean. Yet when gold prices plummet, fear takes over and some investors forget the fundamental reasons to own gold: Gold is a portfolio diversifier and a store of value. It is a finite resource with increasing global demand. I co-authored a book on gold five years ago based on a lifetime of experience with the metal. My advice hasn’t changed since then. When it comes to gold, moderation is key. Don’t try to get rich with gold because the corresponding risk is simply too high. Limit your exposure to gold as an asset class to 10 percent of your portfolio—no more than 5 percent in bullion and 5 percent in equities. Rebalance each year to keep that level of exposure and use volatility to your advantage.

Year-Over-Year Percent Change Oscillator: Gold Bullion
click to enlarge

There seems to be an inherent emotional bias against gold by many in the financial media and among money managers, especially after gold corrects. Billions of dollars lost in gold make for sensational headlines, yet two darling technology stocks have also taken it on the chin. I find it interesting that the naysayers aren’t talking about the fact that Facebook and Apple have caused more destruction in market capitalization over the past year than the biggest gold ETF. The chart below puts the magnitude of decline in context.

Facebook and Apple Lost More in Market Captialization that GLD Over the Last Year
click to enlarge

Why is it that gold still struggles for acceptance as a permanent asset class? I, too, enjoy catching up with Facebook friends on my iPad, but I have more faith that millions of people in Asia and the Middle East will continue to adore the precious metal long after the novelty of Facebook and iPads wears off.
In many parts of the world, this deep cultural affinity for gold is expressed through the giving of gold coins and jewelry for momentous occasions. Gold will soon be entering its historical period of seasonal strength with Ramadan beginning in July, followed by the Indian Festival of Lights, wedding season and Christmas. We have often published on the impact of this powerful seasonal pattern.

Gold: 24 Hour Composite--Historical Patterns
click to enlarge

In addition to spooking the gold market, the likelihood of the Fed ending its easing also had investors fleeing fixed income investments. Rising interest rates and falling prices led to June bond fund outflows shattering the previous record set in October 2008. Yet downward revisions of economic data suggested that while the economy may be steadily improving, there aren’t yet signs of spectacular growth. In response, bond yields retreated by the end of last week. We see the exodus as an entry point for investors who may have been nervous about getting into the bond market.

Fed fears reached far and wide as emerging market equities also experienced record outflows this month as the sell-off extended to Latin America, Europe and Asia. Renewed worries over Chinese growth and concerns with tightening financial conditions accelerated the flight from emerging markets. Money that had been made in recently hot markets was pulled out, further drying up liquidity. We continue to see opportunity in emerging markets, where we seek out undervalued dividend-paying companies with growth prospects.

From time to time, in bull markets and bear markets, prices and fundamentals disconnect. Prices can swing too far on fear and rise too fast on greed. We believe fundamentals remain solid and much of the short-term swings are much ado about nothing. In volatile markets, it is important to trust your investment processes and asset allocation disciplines.

By Frank Holmes

CEO and Chief Investment Officer
U.S. Global Investors

All opinions expressed and data provided are subject to change without notice. Some of these opinions may not be appropriate to every investor. Diversification does not protect an investor from market risks and does not assure a profit. The following securities mentioned in the commentary were held by one or more of U.S. Global Investors Funds as of 03/31/2013:  Apple, SPDR Gold Shares (GLD)

Disclaimer: The views expressed in this article are those of the author and may not reflect those of Kitco Metals Inc. The author has made every effort to ensure accuracy of information provided; however, neither Kitco Metals Inc. nor the author can guarantee such accuracy. This article is strictly for informational purposes only. It is not a solicitation to make any exchange in precious metal products, commodities, securities or other financial instruments. Kitco Metals Inc. and the author of this article do not accept culpability for losses and/ or damages arising from the use of this publication.
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