First, our original analysis used monthly data given its availability over long periods of time. But we can build our simple regressions using daily data for the last few years. At face value, it would appear that the model that has worked since the events of late 2008 continues to work pretty well as shown in the chart on the left.
But closer inspection of the last 12 months or so suggests that something subtle has changed about gold's performance vs. our key variables. In particular, real interests have continued to drop to extraordinarily low levels, but gold has largely been unmoved.
This point is illustrated in the chart on the right. When overlaying a regression of gold based on the last 12 months to the performance of the last few years, its clear that this model has little explanatory power of why gold so strong through 2009 and 2010.
What is most unusual about this change in behaviour is that appears to have been driven by an event that most would have thought would have been bullish for gold. The widening of the ECB's measures to combat the intensifying crisis at the end of 2011 was thought to be an event which would have bolstered gold prices. But this event seems to have more of a profound impact on debt markets which didn't carry through to gold or FX markets.
One simple way to look at it is that real interest rates (using US 10 year TIPS) are now dramatically lower than in September 2011 when gold was pushing above $1900/oz, which has been the pillar of mosts bullish expectations in the last 12 months.
But gold prices are lower, largely as its taking is cue from a stronger US dollar.
In my view this change in behaviour leaves gold in limbo in the short to medium term. US real interest rates are only likely to go up, which is bearish. But more importantly, there seems to be little conviction in FX markets on the direction in US dollar. The ugliness contest developing between the major currencies means that while you might have good reason to sell dollars, do you really want to buy Euros or Yen?
Some might argue that this is precisely why gold should flourish from here. But recent behaviour suggests this isn't the case. My view is that gold is simply to scarce to be a meaningful alternative to major currencies for those that are making the key investment decisions. While this may change, there is no signs that it will anytime soon, with the major change in allocation already occurring.
So in a nutshell, while we wouldn't be calling for a dramatic decline in gold prices, it does look like money would be better invested elsewhere at this stage.
Finally, gold investors will have conscious of golds performance in the currency they wish to sell into. For Australian investors, currency is a big issue not just for gold but investing in anything offshore. For Indian investors, gold has been a nice hedge against a weak Rupee, although the strength of Rupee denominated gold has weighed heavily on physical demand from the world's second largest consumer.
