After gold declined to a 5-year low, the message is that gold is doomed. Is it really true?
In the past few weeks, the price of gold has suffered a significant decline, indicated by multiple technical signals and triggered by China's disappointing disclosure of its official gold reserves on July 17 and the following heavy selling in the Asian market. Gold bullion dropped by 6% in July, significantly deteriorating the market sentiment toward the yellow metal. Indeed, the sentiment indexes fell to record lows.
It seems that quite a few gold investors threw in the towel, as hedge funds became net-short in gold for the first time since 2006.
Generally speaking, there is negative sentiment all over the market. Media stories became bearish with headline articles such as “Gold is doomed” or “Gold is only going to get worse”. Financial analysts are racing to suggest the lowest price target. According to Goldman Sachs, the yellow metal could fall below $1,000, while Deutsche Bank says that gold’s fair value is $750.
Are these bearish predictions right? Well, of course the price of gold could drop further, but most likely not based on reasons that you can currently read in the mainstream media right now. Please recall that the same forecasters calling for the end of gold right now are often the same ones that called for $2000 when gold was rising. The best example is Deutsche Bank, which in October 2012 was forecasting the price of gold at $2,113 or even 2,200 in 2013. We all know what happened a half year after that gold price forecast.
Investors should remember that since gold does not generate cash flows, precise predictions based on standard financial models are very difficult and such models are usually employed by big financial institutions. There are many other things that need to be taken into account that are not in the standard textbooks on capital markets.
It should be clear now that the price predictions of most analysts seem to follow the momentum of gold – in the bull market, they forecast more increases, while during the bear market, they call for more declines. This is why investors should always take them with a pinch of salt. Actually, from a contrarian point of view, strong negative sentiment is a precondition for a next bull market.
Summing up, the sentiment toward gold became negative, but that doesn’t mean that gold is really doomed. Sentiment changes along with price and the only thing that the gold-is-doomed comments are really saying is that we are not close to a major top but close to a major bottom. All markets move from extreme optimism to extreme pessimism and vice-versa and it seems that the gold market is simply in the latter type of environment. Multiple long-term fundamental factors remain intact and just because the price of gold moved temporarily down and we read many bearish opinions doesn’t invalidate it.