On August 10, Ray Dalio, chairman and chief investment officer at Bridgewater Associates wrote in a LinkedIn blog post that investors should own 5-10% of their assets in gold. There have been many such calls in the past seven years by different experts, which haven’t been profitable. Therefore, let’s evaluate the conditions and decide whether it’s the right time to invest in gold?
- Gold has is a time-tested asset class
- Gold is a safe haven, though experts have differing opinions
- Any crisis emanating from China, Japan or Europe can see a risk-off trade being taken
- Geopolitical tensions are another catalyst for gold
- The downside is limited and clearly defined
- Buy in a staggered manner as it is difficult to nail the bottom
What is gold’s status as an asset class?
Gold, as a precious metal and as a medium of currency has a very long history. The first known gold coins were used somewhere in 6th century BC, while gold mining is believed to have started at least 7000 years old.
Even in the last century, the world’s major nations were following a gold standard. Many opine that it was the best system and there have been intermittent calls to return to the gold standard to avoid credit bubbles stoked by the central bank’s ultra-loose monetary policies. This shows that gold, as a form of currency or as an asset has withstood the test of time.
Why is gold perceived as a safe haven?
A safe haven investment is one, which retains and sometimes increases in value during tumultuous market conditions when the perceived risky assets lose value. However, the researchers differ in their opinion about gold’s performance as a safe haven investment.
In a study by Baur and Lucey (2010), the authors noted that gold works as a safe haven only for a short time, about 15 trading days and is only effective as a hedge against stocks and not bonds. In another study, Baur and McDermott (2009), found that gold performed both as a safe haven and a hedge against the US and European equity markets but not for the remaining developed nations and the emerging economies.
On the contrary, researchers in Ireland concluded in their paper “Reassessing the Role of Precious Metals as Safe Havens – What Colour Is Your Haven and Why?” that gold acts as a safe haven in turbulent times in many countries. This was because of the low correlation of gold with the other markets, as shown in the table below.
|Gold||MSCI World||MSCI Asia ex Japan||S&P 500||Japan||JPM Global Bond|
|MSCI Asia ex Japan||0.24||0.84||1||0.76||0.65||0.43|
|JPM Global Bond||0.55||0.29||0.43||0.18||0.11||1|
Monthly data from May 2011 to May 2016
Source: Bloomberg and Stansberry research
Gold acts as a safe haven investment during times of political and financial market stress, however, its effectiveness reduces once the markets move towards normalization.
What is the current situation that benefits gold?
We have a political gridlock in the US. It is unlikely that the current administration will be able to push through critical tax reforms or be able to boost fiscal spending to a level that will accelerate growth. If the Fed tightens and takes steps to shrink its massive balance sheet without adequate growth, the stock market is likely to fall.
The central banks kept interest rates low for an extended period and printed astronomical sums of money to drag the economy out of the financial crisis. Many experts believe that the central banks have used up all their bullets, therefore the next crisis will be severe and will last longer. If such a situation happens, gold might be the only place to hide.
Japan and China are sitting on piles of debt. Any major crisis in either nation will be catastrophic and may lead to a risk-off trade, where gold will be a beneficiary.
Also, the heightened geopolitical tensions between the US and North Korea, the trade conflicts with China, the uncertain relationship with Russia, and terrorist attacks can quickly turn ugly, boosting a move towards safe haven investments.
Ned Naylor-Leyland, manager of the Old Mutual Gold & Silver Fund notes that gold completed a golden cross in December of last year. A golden cross is when the 50-week moving average moves above the 200-week moving average. Every time the golden cross has occurred in the past 30-years, it has led to a bullish move in gold that lasted at least for three years, according to Naylor-Leyland. In fact, the last time this occurred in 2002, after which gold embarked on a massive bull run.
What is the downside risk in gold if we are proven wrong?
As seen above, gold can protect your wealth in case of a black swan event. Therefore, keeping a certain portfolio in gold is a good strategy.
The risk is that the investment made in gold will not return a dividend or pay any interest. It will remain as a dead investment until you sell it. The US markets can extend their bull run for a few more years. Under such a circumstance the investment done in gold will be a wasted opportunity. If the risk on trade continues, gold will fall out of favor and may fall.
After understanding the fundamentals, let’s see what do the charts forecast.
What do the charts forecast for gold?
Gold remains in a long-term uptrend. It completed a 50% Fibonacci retracement of the large upmove from $255.1 to $1923.7 and is currently stuck in a range between $1045 on the lower end and $1400 on the upper end.
Gold was similarly stuck in a range after topping out in 1980. Subsequently, gold remained in a trading range for about 21 years, before starting its next uptrend in 2001.
The present consolidation is already in its sixth year. If history repeats itself, gold may remain in a trading range for a long time before starting a new uptrend.
However, the downside seems limited. Therefore, traders can buy gold on dips and sell it on rallies near overhead resistances. All long positions should be protected with a stop loss of $1030.
If, however, the world faces any new financial crisis, gold can resume its uptrend and rally to new lifetime highs. However, it is difficult to pin point when this is going to happen. As many traders don’t want to hold their positions for the long-term, let’s analyze the daily charts for short-term buy setups.
On the daily charts, $1300 is a strong resistance, as gold has returned twice from those levels. On the downside, $1200 is a strong support because gold has bounced twice from these levels. Therefore, a breakout of $1300 will most likely carry gold to the upper end of the larger range to about $1400 levels. On the other hand, a breakdown below $1200 will push gold down to $1120 levels.
However, as gold has been in a range and it has a history of long consolidations after a stupendous rise, long-term traders can invest in a staggered fashion.
First 25% of the proposed allocation can be done at the current levels. If, however, gold fails to breakout, the next 25% allocation can be done at the lower end of the range at $1200. We expect this level to hold.
The final 50% allocation can be done when gold resumes its uptrend. All stops should be kept at $1040 levels.
Our risk is defined, but if the world faces another financial crisis, gold is likely to rally to a new lifetime high.