The big news in investment markets is not the Greeks accepting the bailout, nor the ups and downs of the Chinese stockmarkets in Shanghai or Shenzhen. Rather, it is the fall in the price of gold.

In case you missed it, the price of gold has been falling since mid 2011 and we are now into year 4 of a bear market in gold. It peaked at just shy of US $1,900 an ounce, and this week crashed below US $1,100 an ounce. Monday’s rout that saw gold fall more than US $45 an ounce during Asian trading hours – its steepest one day fall in more than 2 years – might have occurred in relatively unusual circumstances, however its failure to recover in price since then says that buyers are on the sidelines and the underlying demand for the metal remains weak.

Gold Spot Price in US Dollars – 2005 to 2015

Source: CNBC

Gold Spot Price in US Dollars – Last 30 days

Source: CNBC

While I am a perennial gold bear and also hate investing in assets that I don’t understand or that don’t pay any income – both true for gold – the fall in the price of gold has implications for how we should position our investment portfolios. If we assume that the “smart” money really does know what they are doing, this is what they are telling us.           

What the fall in the gold price means

Firstly, investors now recognize that the risk of a geo-political shock is at its lowest point in some years. This is not surprising. The Greeks and the Europeans have come to terms such that the inevitable “Grexit” has been booted into touch for a couple more years, the Iranians and the Americans have concocted a deal that may limit Iran’s nuclear ambitions, the Americans are also cozying up to Cuba and Putin seems to have gone a little bit quiet on the Ukraine.

Moreover, what the gold market is saying even more emphatically is that all that scary talk of a sovereign debt crisis – remember all those so-called “experts” who were predicting doom and gloom in 2011 – is wrong. The central banks have won. Debt is not going to lead to a global economic meltdown or depression.

Next, the gold market is saying that the US dollar will continue to strengthen. A buoyant US dollar will have huge impacts on global capital flows – investors in emerging markets, in particular, beware. It is also bad news for the hard commodities which are priced in USD, such as copper, manganese and iron ore. While an improving economic outlook for the USA and Europe may in the medium term lead to a pick-up in demand, the short term outlook is continued price weakness for hard commodities.

Finally, interest rates are on their way up. The first rate move in the USA is expected in September, and it is looking likely that a rate hike will occur in the UK within the next 12 months. In Australia, while we may yet see a further small cut, the signals coming from the RBA are that they are pretty comfortable about where rates are. David Bassanese knows a lot more about the mysterious workings of the RBA than I do – you can read his assessment of the latest RBA Board minutes here http://switzer.com.au/the-experts/david-bassanese/spotlight-on-the-rbas-statement/

Implications for investors

Starting with the obvious, continue to avoid Australian gold shares. While the AUD equivalent price in gold has been a lot more stable, Australian gold miners are highly leveraged to the gold price. When sentiment is bad on the gold price, sentiment is bad on gold miners.

Secondly, continue to bias your portfolio to sectors and companies that will benefit from weakness in the Australian dollar. Companies that earn a major share of their revenue in the US or US dollar tied countries are the obvious targets, such as CSL, Cochlear, Resmed, Computershare, Macquarie Bank, James Hardie, Amcor, Orora and Brambles. While some of these companies are getting a little expensive, they are still amongst the best performing stocks on the market and barring any earnings surprise, should continue to perform. Some of the international fund managers, such as BT Investment Management, Platinum, Magellan and Henderson could also be considered.

And if investing in fixed interest (either directly in the bond market, through term deposits or even through a fixed income fund), try to keep the duration (ie effective maturity) relatively short. With a positive yield curve, this means trading off lower returns in the short term. However, the bond market is foreshadowing higher interest rates, so investing with a shorter term now or in floating rate securities will minimize the risk of capital losses down the track.

The good news for equity investors, however, is that gold market weakness signals increasing confidence is less earthy assets such as shares. It is a vote of confidence in the share market.