Is Now a Good Time to Buy Gold?

by Russ Koesterich, Chief Global Strategist, iShares

Gold prices are down roughly 25% in 2013 and the precious metal has clearly lost some of its luster. But many investors are now asking: “Given the selloff, is this now a good time to buy gold?”

My answer: no. In fact, depending on their overall allocation, I believe investors should consider  trimming their holdings, as regular readers of my weekly commentaries know I’ve been advocating for the past six weeks. While I still believe that the precious metal should be a part of a diversified portfolio, I see four reasons why gold prices are likely to decline going forward.

1. Gold prices are facing the headwind of rising real (adjusted for inflation) interest rates for the first time in years. An environment of rising real interest rates, like the one we’re in today, should create a less supportive environment for gold prices. This is because real interest rates, which equal nominal interest rates minus inflation, are essentially the cost of holding gold, an asset that generates no interest income. When real interest rate are rising, as they are today primarily thanks to an increase in nominal rates, investors holding gold are forgoing more and more interest income.

2. A strengthening dollar doesn’t bode well for gold prices. When the Federal Reserve likely begins tapering its asset purchases this fall, the dollar should appreciate against other currencies, including gold (gold is arguably the oldest currency in the world).

3. Sentiment has clearly changed lately in the gold market. The positive sentiment toward gold that caused many to pour money into the precious metal over the past few years has shifted. Want evidence of this? Look no further than the abundance of articles and posts lately just like this one.

Some of the positive sentiment toward gold over the last few years can be attributed to investors’ expectation of quickly rising US inflation, an outlook that did not materialize. With inflation stable over the last year and likely to remain modest in the coming year, investors’ desire to hold gold is subsiding and gold prices are dropping.

4. Demand for the precious metal may be declining. India is the largest single country consumer of gold, partly for cultural reasons and partly as a hedge against long-term inflation. However, India’s money supply growth, a leading indicator for the country’s long-term inflation and a proxy for the country’s gold demand, hasn’t grown lately. Meanwhile, the fraction of total gold output held by central banks around the world has continued to decrease over the last decade and a sharp reversal in this trend is unlikely.

To be sure, gold, like most other asset classes, is likely to remain volatile in the coming months amid continued investor speculation about the end of easy money from the Fed.

In addition, there’s always the chance that gold prices may regain their shine if US inflation seems more likely to spike, if people once again start questioning the survival of the euro and or if the world economy experiences another exogenous shock. But absent those scenarios, I’d continue to lighten up on the precious metal.

Source: Bloomberg

Russ Koesterich, CFA, is the iShares Global Chief Investment Strategist and a regular contributor to the iShares Blog.  You can find more of his posts here.

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