Why gold is not as lucrative an investment these days

Falling prices, bearish sentiment prevail for now.

In a new commodities outlook, OCBC breaks down the factors in recent months that have led to the steep decline of gold prices, which have plummeted below $1400/oz, and the possibility that the rest of year will continue to put pressure on the commodity.

Here's the complete analysis from OCBC:

Since the beginning of the year, gold faced strong headwinds as investors chased stock markets to record-high while abandoning alternative investments like gold. The bullion ceased its 12-year bull run and had repeatedly broken its key psychological supports at $1650, $1550 and recent $1400/oz with its latest 13.0% plunge from its last week’s high, and possibly eroding any remaining hopes of a gold bull run this year.

The obvious cue to the increasingly bearish environment is the fall in ETF holdings from 84.62 million ounces in Dec 2012 to the latest 77.36 million ounces, with big players like George Soros indicating his reduction of his gold holdings by 55% in 4Q12, while Jim Rogers comment that the bullion has not corrected enough. Speculation that the US may moderate their bond purchases this year and finally ceasing it completely by year-end only added to the bearish sentiments. With the market thus looking for the slightest reasons to sell the bullion, mere rumors of a gold selloff by the Cypriot government was the final straw that broke the camel’s back and sent gold testing to its $1,400/oz support, the lowest in 2 years.

In order to gain a better sense of how gold is to behave for the year, we need to re-consider the factors that may have effectively erased any bullish sentiments on gold. We recognize that the Fed may eventually moderate its QE3 program this year should the employment outlook improves, thus allowing for a gradual appreciation of the USD by year-end. However, it is noteworthy that the FOMC committee members also recognized the negative drags to growth by the on-going federal spending sequestration amid elevated unemployment, and stating that the benefits of the “current purchase program outweigh the likely costs and risks”. Furthermore, the Fed is the only key central bank that is considering unwinding its easy monetary policy; the ECB is hold while the BOJ is expected to aggressively ease in order to achieve its 2.0% inflation target. In addition to the economic headwinds seen in the US, we note the World Bank’s downgrade of its global GDP outlook to 2.4% yoy (vs a prior forecast of 2.5%) amid the lower-than-expected China 1Q13 GDP growth of 7.7% (vs market consensus of 8.0%), suggesting that global economic growth may not be as stellar as what market hoped at the start of the year.

The surprising factor for the gold plunge (at least to us) is the rumors of a gold selloff by the Cypriot government despite the authority’s assurances that it has no intention to deplete its holdings. The rumors are likely hardly the reason for the plunge in gold prices; Cyprus gold holdings are at a mere 13.9 tons, which only accounts for 0.045% of global gold holdings, and a sell-off (should it occur) should be a non-event considering how minute its holdings are. While a gold sell-off by Cyprus may open the doors to other debt-strapped peripheral wagon”. Eurozone countries like the GIPS (Greece, Ireland, Portugal and Spain) to sell its gold holdings to cover it debts, it is important to note that they do not have a bountiful of gold reserves to begin with, with their total gold holdings amounting to a mere 782 tonnes, or 2.5% of total gold holdings. As such, with the market catching any slightest reason to short gold, investors collectively “jumped off the (bull) wagon”.

In respect to future gold prices, we lean in preference towards fundamental reasons including the possible uncertainties in the global recovery, noting fresh Eurozone debt woes and the softer Chinese GDP headline, amid a continued negative real interest rate environment and easy liquidity from key central banks. We highlight the possible over-reaction by the market in “jumping off the wagon” and point out the futility of any gold movement should PIGS (let alone Cyprus) engage in a gold sell-off to cover their debts. However, in the near term, gold bears may continue to dominate as the bullion attempts to catch a falling knife, and any movement below its $1,400/oz handle may result in another depreciation to its next support of $1,330/oz.