Gold bugs have been disappointed with the performance of bullion since the precious metal topped $1,800 per ounce several years ago. It closed at $1,220 on September 26th..
The USD has appreciated for eleven straight weeks, a streak unseen since 1967. This comes as investors foresee an end to the Federal Reserve’s QE3 money printing program and a more predictable path to higher interest rates.
Investors once bought gold as insurance against systematic risks such as inflation or an unanticipated market disaster. There’s no shortage of geopolitical risk around the globe today. From ISIS to Russia/Ukraine to congressional gridlock to an Ebola outbreak, investors do not need to look very far to find something to worry about. Nevertheless, the price of bullion has responded with an inverse movement to proliferating risk.
More concerning than the divergence between price and global risk is the underlying, or functional, value of gold, or lack thereof. Gold doesn’t serve an economic purpose. It isn’t used to construct buildings, assemble cars, or develop technology. Value investors make money holding securities, mostly shares of companies, over time, during both expansions as well as recessions. Companies that are attractive to value investors usually command pricing power. Conversely, gold producers are price takers in a market where, uniquely among commodities, no product is ever consumed. It is simply stored, adding to the stockpiles previously accumulated. Unlike commodities such as oil, grain or copper it is impossible to run short of gold, since it never gets used up.
Because gold prices have failed to respond to geopolitical risk and because gold lacks any sort of intrinsic value, investors would be well advised to move their capital into companies with the pricing power necessary to grow their earnings over subsequent business cycles.