Are you bold enough for gold?

It’s when a volatile but recurrently coveted asset is out of favour that it tends to be worth considering for the personal portfolio. That’s the essence, after all, of value investing, particularly for the medium term.

Having been the darling of imaginative investors in recent years, gold quite abruptly became shockingly out of favour last month, when prices plunged to around $1350 an ounce, having begun the year near $1700. Since then they have experienced something of a bounce of some ten per cent, while remaining decidedly below the $1500 mark.

So does that make it especially biddable now, or have the conditions in which it came into reckoning changed to its lasting detriment? Or maybe it was just another momentum-based bubble all along?

At the core of that issue is what type of value gold truly has to offer. Opinion is thoroughly divided on that issue, among economists, financial market participants, officials, and the man and woman in the street.

The spectrum of differing attitudes encompasses those who perceive gold as the epitome of real money, not the paper variety whose printing is so utterly and evidently at the whim of governments, to those who identify this mined but relatively unremarkable commodity as having mystical worth, whether that is a good or bad thing.

Both those camps recognize that a key characteristic of treating gold as money, particularly at an official level as a policy benchmark, is that it could restrict the ability of governments to manipulate their national currency, in particular to weaken it either internally (higher inflation) or externally (i.e. a lower exchange rate), affecting the relative purchasing power of citizens.

Depending on which side of the argument you prefer, that potentially is its virtue or its vice.

Most of those interested, however, are mainly concerned with gold as an investment; why it fluctuates so wildly, and where it is heading.

In order to generate some sensible idea of what’s behind the rise and sudden fall of the gold price, and therefore a reasonable basis to look forward to likely trends, a combination of fundamental, economic, and market or technical influences need to be taken into account.

That said, it will still be a matter of choosing among theories and scenarios rather than divining some distilled, determining factor on what will happen next. That’s the reality of markets -- it takes two to tango, a buyer and a seller, who, unless committed for commercial reasons to participate, may have quite differing views on what will drive market direction. The preferred time-horizon of the investor concerned is also naturally relevant.

Firstly, as to the fundamentals, it is generally understood that the supply of gold is naturally constrained, literally unearthed, or released from stocks, or recycled only limitedly year by year. On the other side of the equation, however, demand is to some extent structural, reflecting the cultural attachment of some societies to jewellery especially, and otherwise cyclical, that’s to say responding to price in the conventional way.

In recent weeks there have been clear signs again of demand for the physical commodity, as was always likely from India and China. The mild recovery in prices into the mid-$1400s has in fact owed substantially to the opportunism of traditional consumers and industrial users whose interest is particularly price-sensitive, but nevertheless ongoing.

Secondly, as to economics, the main themes that have propelled gold prices since the financial crisis have been the dangers of economic chaos and/or inflation. The dire state of the Western economies, massively encumbered by public debt, has sponsored the view that the authorities have lost control, and gold represents a safe haven, but also that their attempts to escape their indebtedness will involve huge reflation of the money in circulation, deliberately depressing the value of cash. Gold would instead, as (very roughly) historically, hold its value over time in terms of goods and services.

Of course the various programmes of so-called quantitative easing (QE) by key central banks in the US, UK and notably now Japan have inspired that expectation. In Europe these desperate attempts at ‘pump-priming’ the real economy by monetary stimulus -- since the scope for budgetary impetus has apparently been stretched to the limit -- have been restrained by the attachment of Germany, the dominant economy, to principles of sound money and balanced budgets.

The deep concern of investors, overall, became manifested in the gold price, especially since access to the precious metal had been facilitated by the growth of exchange-traded funds (ETFs) as simple vehicles for gold exposure without actually owning the metal itself.

Thirdly, financial markets are known to be prone to overshooting, exaggerating underlying trends. The herd instinct which produces that effect is known across asset classes, commonly in equities and real estate. There are some who subscribe to conspiracy theories about governments intervening to regulate gold by subterfuge, but those ideas aren’t needed to explain why prices can be so violently variable. Pure speculation can do that job.

For instance, the fact that gold pays no income (yield), and so relies on the prospect of capital growth (price) for return on investment, is enough to make it vulnerable to sharp swings. Moreover, just as with other, closely-followed investments, it is subject to the floors and ceilings of various chart levels, the breaching of which can signify immediate movements up or down to the next level that traders monitor and adhere to.

As a plausible viewpoint, however, this correspondent would suggest that the essence of the recent shift down probably combined two ingredients which relate especially to the market and economic factors.

First of those is fatigue, in relation to the persistence of a very generally sideways pattern, and therefore failure of gold to climb back towards its peak of September 2011 above $1900 an ounce.

The benefit of the possibility of such a rebound was eventually outweighed by the cost of zero income, which was not such a drawback relative to near-zero deposit rates, but since the first quarter of this year has increasingly become unacceptable in light of the comparison of surging stock markets and associated dividend payments. Moreover, volatility itself has lately become a stumbling block for an asset supposedly offering security.

Second is a kind of re-reading of the economics of the age. Governments are indeed trying to reflate their way out of trouble, but equally are failing -- in my view on two counts.

One is that managing aggregate demand, whether contraction (austerity) or expansion (stimulus) ignores that the supply side has seized up, i.e. in terms of the workings of product and labour markets, and the burdens on business of tax, regulation and various bureaucratic obligations, as well, perhaps most importantly, as the buffeting taken by the banks.

Systems have basically buckled, and bust will follow boom, regardless of official efforts, as deleveraging of debts work out. That is arguably true right across the developed world, and to the extent that emerging markets serve those blocs, they too are restrained. So growth is difficult to revive promptly, and inflation depends considerably (though not exclusively) on growth to advance. The Eurozone is its own special case in that midst, snarled in self-contradictions.

The other is that QE -- the policy recourse most obviously relied upon recently, and to which gold investors have specifically reacted -- has not impacted even nearly as hoped or feared, or is now subject to diminishing returns, or indeed has had perverse, unintended consequences.

Without getting overly precise, the targeted suppression of both short and long interest rates, epitomized by government treasury markets, has had much more of a monetary than real effect.

In fact, it has been noted that, by curtailing the mainstream maturity transformation business of the banks (borrowing short at one interest rate and lending long with a clear and reliable margin), QE has damaged credit creation and actually inhibited growth of the money supply, critical to regenerating economic activity and enabling demand! It is, frankly, a disturbing indictment of the policymaking consensus at global level.

So neither growth nor inflation have materialized very much, or seem likely to do so. That realization has just taken hold. Gold therefore ran out of puff and fell to the ground.

On the basis of unchanged international policies, it may take a while to revive. The fact that it nevertheless might do so -- at least in bursts, even if it doesn’t become another mania -- means that it could still logically form a modest portion of investor portfolios, which is really what it should always have done, nothing more or less. This current period of downturn naturally means that the upside, conceptually and by revealed history, is actually that much greater.