Rebalancing gold

16 Nov 2010 by Jim Fickett.

The long run-up in the price of gold has brought its share of the portfolio too high. In the interest of rebalancing, and because gold seems to be as much driven by commodity markets as financial and monetary fears, I am starting to sell.

I sold a small amount of gold today. Most of the gold I have I bought long ago, and, as the price has risen, gold's share of the portfolio has risen. It went over 10% recently, and that is more than I want to risk on something that is so difficult to value objectively. Rebalancing in such a situation is a good way to force yourself to stop worrying about exactly where the top might be, and do the most important thing, which is to sell while the price is relatively high. I will probably keep selling small quantities over the next few weeks to bring the portfolio share down closer to 5%.

Although I'm not calling the end of the bull run, there is a worrying sign in recent price action. If you look at the dollar exchange rate, the price of gold, the price of copper, and the price of oil over the last few weeks, the charts all look very similar (with the commodity charts being a mirror image of the dollar chart). One might think that the price of gold would go up with the euro zone facing another episode of crisis, but instead it seems that gold is just following the dollar exchange rate and other commodities.

First think about that from a dollar perspective. Over the last week or so, as tension was building over Ireland, the dollar went up and gold (in dollars) went down. In the usual flight to safety, then, the dollar was perceived as more attractive than gold.

Financial and monetary tension will remain high for years yet and that particular trend will be positive for the gold price. To the extent that the gold price is driven by the weakness or strength of the dollar against other currencies, it is very hard to call – there are some indications that most of the effect of QE2 was already priced in at the announcement. Finally, to the extent that gold (as a component of commodity ETFs) merely tracks commodities, it is also hard to call. For the very long term I am a commodity bull, but the recent run up was impressive, and any slowdown in China could cause a significant pullback.

It is not at all clear which direction the price of gold will go, and there is no margin of safety in the current price.

The gold I sold today was the first I bought (standard IRS FIFO analysis), in 1981, not long after the last peak, at about $440/ounce. The nominal gain therefore looks very impressive, but the real gain is only about 30%.