Gold Sinks Again: A Contrarian Buy?

From April to June 2013, the price of gold crashed to a three-year bottom and suffered one of its biggest quarterly declines ever. After a short-lived rebound, the yellow metal is now back to those levels, and gold-mining stocks have sunk even more.

Gold hit an all-time high of $1,920 an ounce in September 2011. It held up well until October 2012, when it was unable for the third time to get past $1,800/oz again. With the precious metal now down 26 percent in 2013, it’s set to suffer its first losing year since it bottomed in 2002.

This week, the spot price of gold fell to its lowest point since late June ($1,210/oz). So did the two foremost gold exchange-traded funds (ETFs), SPDR Gold Shares (GLD) and iShares Gold Trust (IAU).

Shares of gold mining companies have been hit even harder. The two leading mining ETFs, Market Vectors Gold Miners (GDX) and Market Vectors Junior Gold Miners (GDXJ), both hit new lows this week.

GDX and GDXJ, a smaller-company fund, have tumbled 54 percent and 62 percent respectively this year alone. GDX is now down some 68 percent from its 2011 peak. GDXJ has tumbled 85 percent from its 2010 summit.

For the gold miners, the metal’s sharp sell-off has brought a triple hit to earnings because of much lower average realized gold prices per oz., reduced production and write-downs in the value of reserves. This wave isn’t over yet.

The primary catalyst among several for this year’s sharp gold-price decline has been the slow but inexorable move by the Federal Reserve toward the start of tapering its monthly bond purchases, known as quantitative easing (QE). The Fed first embarked on its QE program in December 2008, when gold was trading around $830/oz.

A major rationale for buying gold, particularly after the depths of the 2008-09 financial crisis, was the belief that the Fed’s aggressively easy monetary policy, including QE, ! inevitably would lead to high inflation and a sharp decline in the dollar.

But inflation has continued to fall, both in the US and overseas, particularly Europe. For example, the Organization for Economic Cooperation and Development said this week that the annual inflation rate among its 34 developed-nation members has declined to 1.3 percent.

The greenback is down from pre-financial crisis levels and its 2009 recovery peak, but it has been relatively stable over the last two years. Any reduction in easy monetary policy likely will boost the dollar, further dampening the safe-haven appeal of gold.

So while US stocks in particular among risk assets have benefited from the Fed’s aggressive monetary stimulus, the yellow metal gradually lost luster as a QE beneficiary. After all, one of the reasons for the stimulus in the first place was that inflation was too low.

According to minutes from the Federal Reserve’s last meeting in October, several board members want to start scaling back the Fed’s $85 billion in monthly bond purchases “sooner rather than later.” However, Janet Yellen, who almost certainly will become the new Fed chairperson as of February 1, has made it clear that she wants to continue the QE status quo for now.

Recent economic reports increase the possibility, although perhaps not the probability, of a Fed tapering as soon as this month’s meeting, which ends on Dec. 18. The most important of these reports came today with the US Labor Department’s announcement that the economy added 203,000 jobs in November, and that the unemployment rate fell to 7 percent, the lowest in five years.

But the key point is that US monetary policy is moving toward tapering. When it finally starts, it should come as little or no surprise to global asset markets, given that the topic has been discussed endlessly for seven months. So the damage, if any, to asset-market prices may prove modest.

The tapering process itself may pr! ove more ! prolonged than anticipated, depending on many factors. In addition, the Fed has vowed to keep short-term interest rates low for a long time to come.

All told, the combination of a gradually recovering economy and low inflation would be a continuing plus for stocks and a negative for gold.

So the current outlook for gold can’t be considered positive. But the price is already down sharply. And the decline in the shares of the gold miners has been exacerbated by tax-loss selling that will end this month.

If you’d like to own some gold as a form of insurance and a hedge against trouble, this is a good, lower-risk opportunity to make a modest new investment or add to your current stake.