The recent crash in the price of gold was the focus of many investors this week. Although several prognosticators have heralded this as the end of gold’s decade-plus bull market, we view it as a correction.

The price of gold broke below $1,400 an ounce Monday, falling to its lowest level in more than two years. Large-scale redemptions in commodity-related exchange-traded funds and hedge funds fueled the selling pressures.

What has caused the sharp decline in gold prices?

• Recent statements from the Federal Open Market Committee minutes have shown increasing signs that quantitative easing may end earlier than expected.
• Speculative positioning in gold futures has declined rapidly, indicating selling pressures from fast-money types of investors, such as hedge funds.
• News last week that Cyprus plans to liquidate a portion of its gold positions has worried investors that further selling from European banks could pressure prices further.
• Important technical levels have been broken; prices have pierced through psychologically important levels such as $1,500 an ounce.
• Investors have become more confident in a sustained economic recovery in the United States.
The U.S. dollar has shown recent signs of strength.

Last October, gold touched its highest levels since 2011, reaching $1,790 an ounce. Investors were uneasy heading into the uncertainty facing the U.S. elections, and inflation expectations were reaching highs for the year — a perfect recipe for higher gold prices. Gold mining equities had also enjoyed a substantial run as gold prices had moved higher and quantitative easing from the Federal Reserve and European Central Bank were in full force.

Since that time period, however, investors’ perceptions of risk have declined dramatically. The elections have come and gone, the ECB has stepped in as the much-needed lender of last resort, and U.S. policymakers narrowly avoided the “fiscal cliff.” Economic data have come in at a slow but positive pace and Europe appears to be showing gradual signs of improvement. This has led to a steep sell-off in gold prices and, to a larger extent, gold mining equity prices. Since Oct. 1, 2012, gold prices have declined more than 23% and gold mining equities have dropped a staggering 45% through April 15, 2013. Additionally, the most recent Fed minutes showed that some members emphasized the Fed should vary the pace of QE, and they have created heightened concern that the flood of liquidity may come to an end earlier than expected. This has led to large-scale liquidations from various macro hedge funds and other investors focused on the short term.

In USAA’s asset allocation portfolios, we continue to maintain an overweight position in gold and gold mining equities. While the short-term moves have been unfavorable, we still believe gold mining equities provide considerable opportunity for the level of risk being taken. In our opinion, the equities have been pushed to levels well below what the fundamentals of the individual companies should warrant. While these types of corrections can continue to move against us in the short term, we ultimately feel that a potentially sharp rally could ensue once the selling pressure subsides. Below are a few of our key rationales for our overweight positions:

• Valuations on precious metals mining companies appear very attractive using various valuation metrics.
• Central banks continue to pursue an easy monetary policy, ultimately increasing the risk of inflation and currency devaluation in advanced countries.
• Despite the added volatility in the asset class, we feel that we are being compensated for the extra risk should valuations revert to historical levels.

Our primary outlook for gold prices remains slightly positive for the following reasons:

• The U.S. is currently facing negative real rates, and based on language and actions from the Federal Reserve, we expect this to remain in place until at least the end of 2014.
• While sovereign debt issues have not hit many headlines, the underlying issues are still a concern and could resurface rapidly.
• Confidence in fiat currencies, or paper currencies backed by governments, has been eroding as the world’s central banks continue to follow inflationary policies.

In other market action, stocks retreated this week, with the S&P 500 index closing at 1,555, down 2.12% on the week. U.S. Treasury bonds rallied (prices up, yields down), with the 10-year yield hitting a new 2013 low and ending the week at a 1.70% yield, down 0.02 percentage points on the week. After plunging to a two-year low Monday, gold rebounded later in the week, closing at $1,404 an ounce, down 5.3% on the week.

Economic Releases Scheduled for Next Week

• Existing home sales
• Richmond Fed Manufacturing Index
• New home sales
• Durable goods orders
• Kansas City Fed Manufacturing Index
• First-quarter GDP
• University of Michigan Consumer Sentiment Index

This material is for informational purposes and is not investment advice, an indicator of future performance, a solicitation, an offer to buy or sell, or a recommendation for any security. It should not be used as a primary basis for making investment decisions. Consider your own financial circumstances and goals carefully before investing.



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