Wednesday, April 17, 2013

Is Gold Attractive After the Selloff?

Gold experienced the biggest decline in history, dropping US$210/oz or 13.7% over two days. Is gold an attractive investment at the current price level?

To answer the question we need to first understand why gold price dropped in the first place. The news about central banks dumping gold triggered the market to rethink gold as an investment vehicle. This is a reversal of the trend in the past few years, when central banks purchased more and more gold as reserve.

The spectacular rise in gold price in the past few years was mainly due to the belief that it is better to hold onto real assets like gold amid the current expansive monetary environment. Many investors, such as John Paulson, do not believe that printing money by central banks is going to solve all the problems  - hence they decided to bet on gold instead. The sudden drop in gold value reminded investors that investing in gold can be risky too. With price dropping 13% in two days, gold is no longer considered a safe haven.

Finally, gold is only worth what the market thinks its worth. Gold is different from other commodities in that the majority of people purchase gold as a storage of value. There is a limited industrial application of gold compared to other commodities such as silver or bronze. Gold doesn't produce any earnings or cash flow; in fact, it would cost you money to store it if you hold physical gold so it has a negative yield. Without limited real application any produces no cash flow, gold is a type of assets that is difficult to value. Some can argue that the floor price of gold is the cost of production, but if the higher cost gold producers don't find it worthwhile to produce gold, they can simply shut the mine down.

With the market now realizes that there is a lot of volatility in gold price, I don't see it going back up to the $1,700 range. Therefore, even though current gold price dropped a lot, I still don't think it is an attractive investment.