When David Gornall started trading precious metals as a 21-year-old in 1981, weekends were a thing to be feared. Only a few brave souls, he remembers, were prepared to trade on Friday afternoon: prices were liable to have collapsed by Monday.
This week brought back memories. On Monday gold suffered an 8.5 per cent rout – the steepest fall since 1983, when the last bull market was in its death throes and daily price swings of 10 per cent or more were common.
“It feels like we’ve gone back to those old days,” says Mr Gornall, who as chairman of the London Bullion Market Association is now one of the world’s most senior gold traders.
The collapse in the gold price has sent a ripple of alarm through the investment world. After 10 years of rising prices, gold investing is no longer the preserve of a few specialists and coin collectors, but a mainstream interest of investors from pension funds and university endowments to savers and retirees from Salt Lake City to Shanghai.
But optimism about ever-rising prices evaporated this week as gold fell $243 from Friday morning to Monday night – the largest move on record in dollar terms, and the third-largest in percentage terms.
Bankers say that their phones have been ringing off the hook with panicked calls from rich clients who have been persuaded to hold 2-10 per cent of their wealth in gold.
“You had a year’s move in 48 hours,” says Paul Crone, founder and chief investment officer of Citrine Capital Management, a metals-focused hedge fund. “A lot of people are in shock.”
Gold investors may be in shock but they cannot claim they were not warned. They have enjoyed a stellar decade-long run, with prices rallying more than 600 per cent to a peak of $1,920 a troy ounce in September, 2011, as fear swept the financial system and drove ever more investors to seek harbour in the metal.
But for every new price high there has been a naysayer decrying gold as an irrational investment. George Soros described it as “the ultimate asset bubble”– although he carried on investing in it until late last year, when he sold almost all his holdings. Warren Buffett mocked gold investors for digging it out of the ground only to “bury it again and pay people to stand around guarding it”.
At a less ideological level, gold traders began to lose their enthusiasm after Mario Draghi promised that the European Central Bank would do “whatever it takes” to save the euro last July.
Since then, the euro has recovered, equity markets have rallied and investors’ attention has been drawn away from gold. “Investors began to ask, ‘Why the heck do we own this thing again?’ ” says Troy Gayeski, senior portfolio manager at SkyBridge, a group that invests in hedge funds.
The market has also been weighed down by factors more specific to gold. Indian gold buying fell sharply in 2012 as the country’s economy slowed and the government raised import taxes in an attempt to reduce the current account deficit. Chinese demand, after surging the previous year, was largely flat last year amid weaker economic growth.
The disappointing demand from two countries that together account for about 40 per cent of global gold consumption meant that buying by western investors became even more important to support the gold price.
But that buying did not happen. Exchange traded funds, whose creation a decade ago helped to popularise investing in gold, began to dump their holdings. In the first three months of the year, the funds sold a record 182 tonnes – equivalent to the annual production of South Africa.
The extent to which investors had fallen out of love with gold became clear last month when a bailout deal for Cyprus threatened to plunge the eurozone back into crisis. Similar episodes had sent gold to new highs but this time the market barely shrugged, inching up less than 2 per cent.
When it emerged last week that Cyprus had agreed to sell its gold to help fund the bailout, a gentle slide became a rout. Jonathan Spall, head of precious metals at Barclays, says this was a “turning point” for the gold market. Goldman Sachs said the sale of gold by Cyprus could be the beginning of “a larger monetisation of gold reserves across other European central banks” and recommended betting on a falling gold price.
Some hedge funds did just that, helping to trigger a cascade of selling that drove gold first to a 10-month low and then to a two-year low. “We were just rabbits in the headlights,” says the head of precious metals at a large gold dealing bank. “No one saw this coming.”
But gold casts a powerful spell. And it will take more than this week’s price declines to persuade its more ardent supporters to sell.
Philip Klapwijk, managing director of Precious Metals Insights, a Hong Kong-based consultancy, likens the most ardent gold bugs to the bittereinders, a small band of Boer war guerrillas who kept fighting even after it had become clear that the war was lost. “If you look at the last bear market, the true believers took an awful long time to start selling – or they had to die and then their children sold their gold,” he says.
The most prominent of today’s bittereinders is John Paulson, the billionaire hedge fund manager who shot to prominence by betting against the US housing market before the financial crisis. In 2009 Mr Paulson decided to denominate a large chunk of his assets in gold rather than dollars, making him one of the world’s largest owners of bullion. He argues that the move by the US Federal Reserve and other central banks to engage in quantitative easing, or “money printing”, will ultimate lead to runaway inflation and the debasement of paper currencies such as the dollar. This week’s price collapse has left him unmoved.
“Federal governments have been printing money at an unprecedented rate, creating demand for gold as an alternative currency,” says John Reade, partner and gold strategist at Paulson & Co. “While gold can be volatile in the short term, and is going through one of its periodic adjustments, we believe the long-term trend of increasing demand for gold in lieu of paper is intact.”
But Mr Paulson’s trade is falling out of favour with others. Despite three rounds of QE from the Fed, and ever larger programmes by central banks in Switzerland, the UK and Japan, inflation remains low and market expectations of future inflation are muted.
Indeed, the inflationary impact is diminishing with each new round of QE, some traders believe, with the third and most recent round launched last summer eliciting only a small rally in commodity prices. The Bank of Japan’s bold promise to double the country’s monetary base by the end of next year has done little to shake their conviction.
“There’s an underlying creeping fear of deflation coming back into the market,” says Tom Kendall, precious metals analyst at Credit Suisse. “Central banks can underwrite liquidity and financial risk but they are running out of firepower as far as getting the economy going.”
Some rival investors believe Mr Paulson will be proved right – investing luminaries Ray Dalio of Bridgewater and Bill Gross of Pimco also reaffirmed their bullish view on gold this week.
But it could be a costly position to maintain. “This consensus that austerity is wrong, that looser and looser monetary policy is right, and that creditors should have to take the hit – this is all the stuff eventually of higher inflation and a higher gold price,” says Mr Klapwijk. “But it might be years before it happens.”
In the meantime, investing in gold increasingly becomes a matter of keeping the faith: that there will be higher inflation, and governments will be unable to do anything about it.
Such faith is not in short supply: even as Mr Paulson was busy fielding phone calls from investors this week, thousands of people with much lower net worth than him were buying gold.
Bankers say that physical demand this week surged to its strongest level in several years as queues formed outside gold shops across Asia and US coin dealers sold out of stock.
At Beijing’s largest gold store, Caibai, people were queuing up to buy gold bars on Friday morning. “I am here to buy gold bars because the price is dropping,” said one woman waiting in the queue.
Sunil Kashyap, head of precious metals and foreign exchange in Asia for Bank of Nova Scotia, a leading bullion dealer, says: “Physical demand is just absolutely incredible. There’s a genuine fear of inflation.”
These buyers see little reason to sell just because prices have fallen. “If John Paulson is not worried about the price of gold, then why should I be?” asks Tobina Kahn, who runs a jewellery dealership in Chicago. “I’ll never sell my gold, honey. No way. I just shine it up. It makes me happy.”
Additional reporting by Dan McCrum in New York, Julie Zhu in Hong Kong and Leslie Hook in Beijing
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