After a decade-long bull market, the rise and rise of the gold price has been pulled up short by a wave of selling. Gold bugs say this is simply a pause on the long march to $US2000; gold bears argue the party is over. For the moment, the bears are winning but the bugs are playing a longer game.
Gold is up 481 per cent since 2002, when it traded at $275 an ounce. It hit an all-time high above $US1900 in September 2011 but it has since fallen below $US1600, down almost 5 per cent this year alone, on a wave of selling. Gold stocks have fared even worse (see graph below.
In the March quarter, global gold exchange-traded funds (ETFs) recorded their largest outflows since the products were launched a decade ago. Much of the selling was attributed to hedge funds, most notably George Soros, who sold half his gold ETFs in February as well as gold equities. In all, 7.2 per cent of ETF gold stores were sold over the quarter.
Nervous investment bankers and brokers were quick to adjust their forecasts. Bank of America Merrill Lynch now says gold will hit $US2000 in 2014, not in 2013 as it previously thought. HSBC expects gold to rally to an average of $US1720 next year before falling to $US1500 over the long term.
Select Investment Partners chief investment officer Dominic McCormick dismisses these views as short-termism and a knee-jerk reaction to recent price movements. ''The growth in gold ETFs is a symptom of the bull market; the recent sell-off reflects a change in short-term sentiment, not long-term drivers,'' he says.
Bugs, hares and tortoises
If investment banks are the skittish hares of the financial markets, central bankers are the tortoises siding with the gold bugs.
Since 2010, the world's central banks have been net buyers of gold as they diversify away from their traditional reserves of US dollars and euros. A recent report by the World Gold Council found that central banks have 8 per cent of their assets in the precious metal.
Gold is traditionally viewed as a safe-haven investment in times of economic uncertainty and geopolitical tension. It is also used as a hedge against rising inflation and depreciation in the value of paper currencies.
In the wake of the global financial crisis, the US, Britain, Japan and the Eurozone have been on what some commentators have called a ''race to debase'' their currencies in an effort to stimulate their economies and become more competitive. They have done this with policies such as quantitative easing, a fancy way of saying printing money.
A prolonged currency war would drive up the price of gold. With interest rates still close to zero in much of the developed world, many observers argue that the stimulatory effect will eventually feed into higher inflation. McCormick says low interest rates also reduce the opportunity costs of holding gold, which does not generate income.
That is the belief of gold bugs such as legendary commodities trader Jim Rogers, who co-founded the Quantum Fund with George Soros in the 1970s. He said as recently as last month that he doesn't think the bull market in gold will end; he views the current price fall as a correction.
Others are not so confident.
''To drive the gold price higher you need something to go pear-shaped,'' Breakaway Research director Grant Craighead says. But unless a rogue state such as North Korea presses the button or a beleaguered nation such as Cyprus goes bankrupt, he believes that is beginning to look less likely.
''With gold equities, and gold in general, you are buying an option on the future price of gold. As the world has settled down and risks have reduced, perceptions of the future have improved and the need to invest in gold has decreased,'' Craighead says.
Fortunately, or unfortunately for the gold price, global inflation is not rising, the US economy is more stable than it was a few years ago and China continues to grow, albeit at a slower rate. Europe is still a basket case, but that's not news. Even so, the gold bears would have to admit that the global economy is some years away from unwinding the high debt and pump priming that followed the financial crisis.
Whichever way the wind blows, Australian investors have not one but two investment decisions to make. The first is whether to invest in gold; the second is whether to hedge the currency exposure to insure against adverse movements in foreign exchanges.
''Arguably the Australian dollar is overvalued but it is one of the few developed economies not pursuing policies debasing its currency,'' McCormick says. ''This means our dollar may stay stronger for longer.'' Ultimately he believes unhedged exposure to gold is probably the better long-term option.
If the gold price rises then Australian investors in unhedged investments could win. If the gold price falls, a depreciating Australian dollar would cushion the blow.
''The bull case for gold prices increasing relies on the US printing more money and inflation rising,'' Craighead says. He and many others believe that is still a real risk.
If the gold bugs are right, then investors who hold their nerve will be rewarded, but they may have to wait a while for the payoff. In the face of so much uncertainty, it would be prudent to follow the central bankers' lead and invest a small portion of your money in gold within a diversified portfolio.