Despite hitting the 12-year low in March 2009 at 666 points, S&P500 index managed to outperform gold’s annual return. Even though, the precious metal has been one of the hottest investment topics in 2009, the S&P 500 finished the year up 26% versus 25% for gold. As of December 31 2009, gold price closed at $1,095, rising for an unprecedented ninth year in a row after traders and central banks joined investors who turned to gold for price performance and protection. In 2009, gold price advanced about $220, a sum eclipsed in recent history only by 1979′s $286 surge. On a percentage basis gold rose 25 percent from its 2008 close, short of 2007′s 31 percent rise.
Since the beginning of the global credit crisis, the investors favored the precious metal as a hedge against economic uncertainties while the commodity traders pushed-up the gold price to uncharted territories. However, after the global equity markets rebounded from the March lows, gold price kept going higher, such that this hedging strategy could not fully explain the commodity’s bullish trend. It must have been then a supply-demand relationship that must have pushed investors to pay up to $1,226 for an ounce of gold. On one side, few central banks played a key role in the 2009 rally: China has increased its reserves over the past five years such that the central bank owns the world’s fifth-largest gold reserve, while India nearly doubled its holdings by buying half of the IMF’s stockpile scheduled for sale. On the other side, the creation of the gold exchange-traded funds (ETF) added to the metal’s rally. Holdings of the world’s largest gold-backed ETF have risen 45 percent in 2009 to 1,134 tonnes, ranking among the world’s largest central banks’ reserves.
Another school of thought has brought-up the double-edged issue: the prolonged easing monetary policy adopted by most of the central banks around the world corroborated with the governments’ massive economic stimulus programs. Such potential issue has induced long-term inflation fears amongst many investors around the world. Consequently, they decided to open long gold positions as hedges against inflation and paper currency depreciation. As of November 2009, the Consumer Price Index (CPI) rose by 1.8 percent, the first positive 12-month change since February 2009. Using the Treasury Inflation-Protected Securities (TIPS), we could notice that the long-term implied inflation is also under control. These findings practically eliminate the inflation hedge as the main explanation for the gold rally. In a similar note we notice that over the last year the US dollar index [DXY] has depreciated by just 4.1 percent which, in turn, proves that the dollar hedge cannot fully explain the commodity bullish trend.
During 2009, there were many analysts claiming that gold is the best investment during a credit crunch, especially during a period of panic across the global financial markets. Looking at the current and past banking crisis, I came to the conclusion that there is no strong correlation between the gold price and the LIBOR-OIS spread. This is a sound result leading to the conclusion that the health of the credit markets cannot explain the long uptrend in the gold price.
In my opinion, none of the aforementioned aspects could fully explain the significant appreciation in the gold price. Instead, I tend to believe that gold is a bubble ready to burst anytime soon. According to the commodity traders, physical gold market is in short supply as it is paper gold. This means that most of trading happening is pure speculative and once the USD carry trade reverses, the yellow metal might collapse precipitously.
Unfortunately besides the gold bubble there are several problems that I can see in the near future. The large amount of money which was pumped into the economy will cause nothing less then inflation, of that I’m sure of. On one hand “cheap money” policies will always cause speculative investments, on the other hand they are followed by continuous inflation. And if the money supply goes dry (ie no more pumping or the interest rate is raised) then we’ll have another crisis on our hands.
But that’s just my two cents…
Istvan,
You are right. However, the inflation, both short and long-term, looks under under control. We all agree that G7 countries are throwing money out of helicopters. The reality shows that all that money does not get into our hands, instead it gets stuck in the trees. Both PPI and CPI are way under water. Let’s see what happens when central banks switch their monetary policy.
Toni,
Unfortunately inflation doesn’t always strikes in the same time everywhere and it doesn’t affects everyone in the same manner. I quote from Hazlitt’s Economics In One Lesson:
“The effect of keeping interest rates artificially low, in fact, is eventually the same as that of keeping any other price below the natural market. It increases demand and reduces supply. It increases the demand for capital and reduces the supply of real capital. It brings about a scarcity. It creates economic distortions. It is true, no doubt, that an artificial reduction in the interest rate encourages increased borrowing. It tends, in fact, to encourage highly speculative ventures that cannot continue except under the artificial conditions that gave them birth. On the supply side, the artificial reduction of interest rates discourages normal thrift and saving. It brings about a comparative shortage of real capital. The money rate can, indeed, be kept artificially low only by continuous new injections of currency or bank credit in place of real savings. This can create the illusion of more capital just as the addition of water can create the illusion of more milk. But it is a policy of continuous inflation. It is obviously a process involving cumulative danger.”
I suspect that so far the PPI and CPI weren’t affected as much as expected exactly because of these “highly speculative” ventures. I think that financial institutions invested most of their money in commodities and the stock market. That could explain why the price of gold and the DJI were positively correlated in the past few months, though normally they should be negatively correlated. Also other metal prices rose even more (ie. lead, copper etc.).
Istvan,
Point well taken. I am not going to get into the reality gap between the CPI and USD purchasing power. From what I pay every day, I can tell you that 2009 meant more than the official 1.8% for CPI.
Listen to this: in a year when the savings accounts paid derisory yields, Americans saved significantly more than they did in any year since 2000.
Toni,
Whoever said last year that he was long S&P 500 and going for 11-12 hundred, is obviously a lier but now what intrigues me is that, even though we are are near 1200, money managers, brokers are projecting/speaking/”promising” about ~20% returns (from now on) but the economy is “growing” at best at ~0% … how can you extract 20% from an economy growing like that ? (It goes for BSE Romania as well I would say)
Of course, the market anticipates the real economy but if we are going like this, in a short time DOW will be 12.000 like “nothing” happened, we are “clean”, we are back in “business”. I feel like now we are or at least heading towards the caution/avoid area of the risk-reward curves and you’ve got 13% RON yielding accumulation accounts as an alternative with a projected inflation 3-6% not to be scared about.
What’s your call Toni ? Don’t you have too something against “this” ?
Bogdan
Bogdan,
As you said we are now back to post-Lehman days. At CNBC I heard that, historically speaking, we have a 80% probability of witnessing another hefty yearly return. As bearish as you could be, you cannot afford sitting in front of a running train.
As far as RO market is concerned, the 13% yield is already history. However, cutting rates will not fix the budget deficit problem as lons as the economy is under pressure. In my opinion, the RO economy will remain under water during 2010.
US will average 2-3% growth while EU will barely stay positive.
Toni,
I didn’t get the CNBC story regarding that but I’m wondering from where does that P 80% comes from.
You can’t stop the train but still 20% more is in my opinion too much even though my BSE account doesn’t mind of course if NYSE goes higher.
After all, it is a personal choice and like Art Cashin started to say (from around DOW 9500) “I’ll start taking some food off the table and leave the banquet earlier”
It is not history yet, there is still an accumulation account which yields 13% (I’ve got some over there) but starting with the 18 Jan they will cut it to 11% which is still not bad and virtually 0 risk if you are not above the “guaranteed limit”.
Romanian economy … yes … anyway, even before we grew more like pushed from behind because the “holes” were bigger here and when it “rains with money” the biggest holes are likely to be felt as fulfilling better then the small ones.
Off-topic – One more thing, CNBC messed it up with the “bubble decade” decade, but 3 days ago, Pro Tv did it too … 2 twins that were born in the New Year’s Eve “were born not just in different days, but in different decades”
Looking at the past recessions, 9 of 11 times, the stock market continued the rally in the following year after the first rebound year.
Excuse my ignorance: what is the accumulation account?
Idiots live all around the world, you can bet on that…
Toni,
Now I know, thank you.
The account is from Intesa Sanpaolo (planul de acumulare) … it is kind of “the last mohican” since 2nd and 3rd place are barely touching 9% and even that, is for higher sums.
Toni,
I never asked you what’s your stand regarding technical analysis “vs” fundamental analysis ? … And if you have different views considering currency markets and separate, stock markets when applying them.
Bogdan
Bogdan,
As everything in life, there is an optimal solution between black and white.
It is clear that FX trading should imply more technical analysis than Equity or Fixed Income trading. Do your homework on fundamentals, read the news and watch the key levels (support, resistance, option triggers, etc).
Sometimes I am thinking setting up a trading boutique…
Toni,
Regarding FA and TA in this subprime ride, the biggest lesson I had is that if only anybody would have used moving average crosses (30,50,150,200) he would have had 3 digit gains (BSE). All that, of course, without paying attention to all the “noise” from media etc but I guess because of that and others, is why it is so hard to be disciplinated, isn’t it ?
Because I’m more with the fundamentals, at the beginning of the rally I was like blinded by it, but luckily, after a while, I decided to go with the crosses and now be safe after the 2008 losses.
I did not look, but intuitively the crosses would have worked with NYSE also since the 2 of them are so correlated.
After all, it looks like, sometimes the simple things, “moves” a lot of the more complicated ones isn’s it ?
Bogdan
Bogdan,
I do not know the BSE, but under normal circumstances trading on crosses alone does not make you a penny long-term. It is more than that. However, if it worked in your case…keep it like that. Ain’t broken don’t change it!
Toni,
“Ain’t broken don’t change it!” … heh, well, I was not that far since I catched/stopped, catched/stopped the “falling knife” from BET-FI 28000 because when you thought it was 88.000 … but who knew it will go to 6700 or so. Anyway, I’m glad I survived the thrilling ride.
From your FX experience, is there some kind of pattern/rule/strategy that when you enter long/short due to technicals/fundamentals, go with just the one of it that was choosed until the end of the position ?
I’m asking you because, on the FX simulator I’m using, , almost anytime I began a position with TA and then made some new decisions with FA or the vice versa, I ended up having a losing trade.
Bogdan
Bogdan,
As you know trading is nothing close to a list of written-in-stone rules. You will find MANY instances where 9 factors are bullsih and 1 bearish and the stock/FX goes down. However, you have to have DISCIPLINE and set-up entry/exit rules. There are many to be said here…
Toni,
Regarding the trading boutique, I guess that would be quite a challenge …
Bogdan
The hardest part is taking the decision to start. Definitely I would like to line-up some capital too…but that’s another subject altogether…
Toni,
I do have some questions that some will sound maybe amateur style but I guess it is never late to start learning.
1) Is there a difference between how commercial banks and investment banks target leverage? I mean in terms of mechanism, process, attidude towards leverage etc.
2) What’s the difference when money managers, brokers, analysts say “the financial analysis of the stock X” or “the fundamental analysis of the stock X” … is there a difference that consists in one of them that is not present in the other one?
3) Is there any pattern between NFP and stock market and/or real economy recoveries ?
Karl
Karl,
I remember one of my professors saying “a very good question is worth 10 good answers”.
1. Investment banks and commercial banks (these days there is no separation between them) have definitely different leverage ratios. Should you reason your question, I would help better.
2. Financial Analysis is a bunch of ratios and other metrics. Fundamental Analysis is FA plus all relevant news about the XYZ company.
3. It is obvious that NFP co-moves together with the stock market and GDP growth rate. You can plot the 3 variables and find the correlation coefficients.
Toni,
1) I was not specific enough. What I’m looking is, since leverage is pro-cyclical for an investment bank that manages its BS actively, so as to maintain a constant leverage of x, when the price of the securities increases, its leverage falls so it will take more debt to readjust the leverage at x by buying more securities. If there is a shock in the securities price, the mechanism works in reverse where equity will bear the burden right ? So, if an inv bank sells securities to readjust its leverage back to the level it was targeting, what does a commercial bank sell to readjust ?
2)Now I got the distinction clear. Now the question is, where is the “valuation of the security x” coming from ?
Thank you,
Karl
Karl,
1) I notice some mixed signals here. What do you mean by “securities”: bank’s equity/debt…or other listed/OTC instruments? From Finance 401 we know that L= D/E. That applies to everything…from Goldman to Microsoft…
2) Valuation of a stock is a math-finance model able to come-up with the price of the stock
These questions have NOTHING to do with the article…What is the real story behind the questions?
Toni,
Sorry for my weird input and also for the wrong place (I didn’t know where to post it differently).
The real story is that I’m having a course on banking and my teacher is teaching things before making clear other stuff. I know this is not tutoring but I gave it a shot
Precisely the statement “leverage for financial intermediaries works different” made me wonder: in comparison with who? how does it work different from others who uses it. I know levels are higher for investment banks but not that it “works” differently.
It is my fault also since I can’t yet make a clear differentiation between what a commercial bank, investment bank, pension fund, production company has on its balance sheet. Maybe the “key” is over there.
The following question is, after all, why do banks target leverage ?
Karl
Karl,
As I expected, your questions reaveal the current level of your financial knowledge. You need to pick-up the Finance 101 and read it back and forth. Then, we could discuss further.
Toni,
What’s your call on the official stats and involvement in financial markets ?
Are equities juiced by the FED (buying futures) since it appears that the money did not come from the traditional players that provided money in the past, volume was not convincing for such a rally, insider buying does not look good etc
Bogdan
Bogdan,
This is another episode from the Conspiracy Theory Movie. I am reluctant to believe that Greenspan and/or Bernanke violated the Federal Reserve’s investment policies. Let me know if you have some proof.
Toni,
I ain’t got no proofs. I just watched a video with Charles Biderman, head of Trim Tabs Investment Research: http://watch.bnn.ca/trading-day/january-2010/trading-day-january-8-2010#clip253604
In another video he says:
“As far as we know it is not illegal for the Federal Reserve or the U S Treasury to buy S&P 500 futures. Moreover, several officials have suggested the government should support stock prices”
He did state though that there is no hard evidence :We have no hard evidence they are, but they could be”
Bogdan