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At the time of writing this post, investors are hurrying out of (precious) metals. Gold is trading around $548 (down $ 22) Silver is at $9.33 (down $0.38), Palladium is $ 288 (down $20) and Platinum $ 1054 (down $16.75).

 

According to Bloomberg the reason for today’s drop is the weaker oil price ($63.25, down $1.85). A drop in the cost of oil eased speculation that inflation will accelerate and erode the value of assets, including equities. However equities are down today as well (S&P -0.75%) as are other commodities, real estate and bonds. So what to make out of all this?

 

Firstly, we notice that the past few months, basically all asset classes have risen in value (except bonds, which were flat to slightly lower). Some called it asset inflation (the result of too much money around, chasing returns), some called it the result of strong fundamentals (equities on the basis of strong earnings, commodities on strong demand from emerging economies and real-estate on the back of  low long-term interest rates).  Although all asset classes rose in value (as measured in say dollars, euros or yen), these assets all lost value when measured in gold. In other words: gold outperformed all asset classes. We would say that was ”the real theme of 2005″ and wonder what the reason for this relative gold strength could be.

 

 

Traditional explanations don’t make much sense. Gold performed well because inflation expectations were moving sharply higher? Not really if inflation expectations as measured by TIPS spreads mean anything. Gold moved up as being the ultimate safe haven in times of trouble? Hmmm, hard to see why other risky assets performed so well then.  Strong demand from emerging economies for jewellery purposes? Possibly, but not according to the Gold Council who’s estimate for gold demand from jewellery in the first 9 months of 2005 is roughly the same as it was in 2004.

 

So what then? We believe the price of gold outperformed because of very strong investment demand for the metal. Demand from (institutional) investor (as their advisors rediscovered the advantages of commodities in diversified portfolios) and demand from Central Banks around the world (especially those outside North America & Western Europe). According to data of the World Gold Council (as per September 2005) officially reported gold holdings as a percentage of central bank reserves are relatively high in e.g. the U.S. (68%), Germany (52%), France (59%) and Switzerland (59%) but on the other hand very low in emerging economies such as India (4%), China (1%) and Russia (4%). So what do these emerging economies have? Loads of paper bills from other nations. And these emerging countries just have to hope that their foreign currency holdings will keep their purchasing power, which is rather unlikely if you look at the rate at which the money supply of “the reserve currency of the world”, the U.S. dollar, is progressing.

 

So, will the Central Banks of India, China & Russia stop buying gold and other metals? We don’t think so. They’ll be happy to pick up what the swift money is eager to dump right now. Will investor demand for the metal wane? Not a likely scenario in our view, as the bulk of investors has only an -at best- tiny allocation of metals in their portfolios. To us it’s therefore clear: buy the dip.

 

P.S: we think it’s rather amusing that today’s sell off in metals comes only a few days after a well established bank (Cheuvreux, read about it here ) stuck its neck out and wrote a 50+ page report on gold, reasoning that investors better start hoarding the metal. Today’s sell off might just provide comfort to those bankers, traders & analysts within the financial community that thought “No, it can be this bad” when reading the report. We don’t judge and investment idea by its one week price performance. Re-read the report and gain confidence that today’s lower prices offer more, not less opportunity.