Gold’s allure dimming as deflation fears grow

Dominick Paoloni had seen enough. Last week, as the euro flirted with its lowest price against the…

Dominick Paoloni had seen enough.

Last week, as the euro flirted with its lowest price against the dollar since January, Mr. Paoloni, chief investment officer and founder of Investment Protection Solutions, sold off 90% of his clients' gold positions, a transaction valued at about $8.5 million. The firm previously had allocated about 10% of its holdings to gold.

“The attitude in Europe is austerity, which is deflationary and could lead to a recession,” Mr. Paoloni said. “Both are bad for gold.”

Gold hit a five-month low of less than $1,600 an ounce last week as the euro fell below $1.30 for the first time since January. The precious metal also broke its 200-day moving average, leading Stifel Nicolaus & Co. Inc. to conclude that the price could be heading toward $1,400 an ounce, according to a Bloomberg report.

Another sign of a possible collapse: The $69 billion SPDR Gold Shares ETF (GLD), the most popular gold fund, fell about 8.3% in the five trading days ended last Wednesday.

“Gold's a funny thing because you can have so many different factors impacting it at once,” said Dan Denbow, portfolio manager of the $2.3 billion USAA Precious Metals and Minerals Fund.

The long-term drivers of gold, such as the threat of inflation and unsustainable deficit levels in the U.S and other developed countries, are still in place, he said, noting, however, that the strength of the dollar has trumped those factors in the short term. “The dollar's the one outlier that could overcome the fear trade,” he said. The U.S. greenback and gold have a strong negative correlation historically, moving in line only during flights to safety, Mr. Denbow said.

Economist Dennis Gartman, who writes the influential Gartman Letter, isn't particularly optimistic about where gold is heading, either. According to Bloomberg News, he sold the last of his gold holdings Dec. 12.

“So much damage has been done to the psychology of the market in the past week, and so many late longs have been caught off guard that we think wholesale liquidation, and perhaps forced liquidation, shall be the outcome,” Mr. Gartman wrote.

Then again, the falling price of gold isn't entirely a bad thing. Advisers who missed out on this year's run-up in bullion now have a chance to get in at an attractive price.

“We pay a lot of attention to the price we're paying for what we're getting,” said Chuck Bender, chief financial officer at The Financial Consulate Inc.

The firm's investment committee is keeping an eye on gold since it likes it as a hedge against a falling dollar, he said. The price of the precious metal has been too high this year, however, Mr. Bender said.

SHORT-TERM SWINGS

Brian O'Neill, president of Cahaba Wealth Management Inc., prefers to keep 3% to 5% of his clients' portfolios in gold. But with the bull run on bullion this year — gold is still up 11% year-to-date — he hasn't felt comfortable buying it for new clients.

If gold falls another 10% or so, Mr. O'Neill anticipates that he will start buying again. In the meantime, he is telling clients not to worry about the short-term swings.

Gold prices are expected to stay under pressure as long as the situation in Europe remains unsolved.

Will Rhind, managing director of ETF Securities LLC, a provider of commodity exchange-traded funds, expects any resolution to be a boon for gold.

Either the eurozone will continue to erode, and fear will overtake the dollar as gold's key driver, or there will be some kind of stimulus that creates inflation, which is another driver of gold, he said.

Mr. Paoloni thinks the latter scenario is most likely, and is watching for signs of it. “If the European Central Bank announces it will start printing euros, it could send gold to the moon,” he said.

This story was supplemented with reporting from Bloomberg News.

[email protected]