How Will the Gold Flash Crash Impact Your Portfolio?
On Monday (20th July 2015), gold prices plummeted 4% within the span of a few seconds, to $1087 / oz.
Published on 23 July 2015
Despite edging higher on Tuesday, gold is now trading at levels not seen since March 2010, and a number of factors seem to be conspiring to keep it low. Here’s how it might affect your portfolio:
The most obvious culprit is an unknown entity in the Chinese market. Shortly after the market opened on Monday, five tonnes of gold was dumped on the market within the space of two minutes. This accounts for about a fifth of the total daily trade in gold, and the move spooked investors enough to start the stampede.
At present, we have only theories as to who or what might be responsible for dumping the gold. Explanations range from high frequency trading algorithms (a favourite scape goat for unexplained market crashes), to a major Chinese investor faced with margin calls from the recent $4 trillion loss in China’s equity markets.
Even without the gold dumping however, there have been good reasons why gold hasn’t been performing well:
The first reason is that China isn’t stockpiling gold near as quickly as analysts projected. In the past six years, during which China has kept its gold reserves secret, there were whispers that the country was buying up gold in massive quantities – looking to shore up its gold reserves by amounts that ranged from 100 – 300%. Now that China has finally revealed its numbers, we see its gold reserves have only risen around 57%. That figure suggests China isn’t buying as aggressively as many investors imagined, and the revelation has taken the wind out of their sails.
The second reason is the recovering US economy, and the rising strength of the US dollar. Along with it, we are seeing the effects of the ending of Quantitative Easing (QE) and a probable interest rate hike. The US dollar and gold have an inverse relationship, and the rising strength of the dollar will make gold more expensive to buyers outside America.
The third reason is the resolution (or at least temporary resolution) of the Greek crisis in Europe. Believers in the financial apocalypse posited that a Greek exit would be accompanied by other departures from the European Union (EU), with countries such as Spain, Italy, and Ireland all leaving the Euro. This would supposedly weaken the EU, which would in turn impact the world economy via a classical “contagion through trade” scenario.
Since Greece is staying however, the situation seems not to have played out, and gold has lost some of its lustre (a bad but appropriate pun) as a safe haven asset.
This combination of factors suggests a recovery in gold will not happen fast. It wouldn’t be surprising for the trend to continue until we’re seeing gold going at $800 – $850/oz. Don’t be too hasty in rushing out to buy.
If you are holding on to gold, you should speak to your wealth manager as soon as yesterday. In some cases, some last minute portfolio rebalancing may be in order. Two things to watch for are:
If gold is part of your long term strategy (speak to your wealth manager if you are uncertain), the current situation is not a cause for panicked selling. Over the long run, this situation is just one of many short term blips on your investment radar. Resist a knee-jerk reaction to sell, as you could be damaging your wealth by selling when prices have already fallen.
Likewise, this should not be taken as an opportunity to start buying. In the face of a strengthening US dollar and rising interest rates, gold is not about to rebound quickly or easily. It is also unlikely that gold prices have bottomed out at this point.
What might be best for your portfolio is to just steer clear of gold for now, but do get the input of your private banker first. If you need financial advice, we can put you in touch with the country’s best financial experts through our quick questionnaire.
Besides other precious metals (e.g. silver and platinum), there are assets that are affected due to their high correlation with gold. One of the most immediate examples are the shares of gold mining companies – the lower margins from gold are forcing some producers into higher levels of debt, and many are already speeding up the closure of higher cost mines. At the very least, you can expect higher D/E ratios and lower dividends from these companies.
It might be a good idea to pore through your portfolio with your wealth manager, and pick out the assets with a high correlation to gold. Pay especial attention to mutual funds or structured products that deal with gold or gold related companies, as it’s easy for these to escape notice. Gold ETFs, once the dividend darlings of the financial world, should also be up for close scrutiny.
Note that, as a rule of thumb, the percentage of your portfolio in gold should be in single digits.
Take action, but do so calmly and with guidance from an expert. These situations are made worse by overreactions. If your portfolio is already affected, don’t panic: a good wealth manager will be able to walk you through the necessary steps, and if you are not satisfied don’t hesitate to make a change.
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