LONDON Fund managers' ardour for gold is cooling as the threat of a catastrophic event in the world economy recedes and expectations of a gradual economic recovery grow, fuelling demand for other assets.
Gold prices have traded in a broad sideways channel between $1,525 and $1,800 an ounce since falling back from a record $1,920.30 in September 2011, and have repeatedly failed to break back above $1,700 this year.
A number of leading portfolio managers have reduced their exposure over the past year or plan cuts this year in response to the receding threat of a euro zone collapse or U.S. debt default.
Economic data has improved recently in both the United States and the euro zone. Although a Reuters poll this month still pointed to soft growth on both sides of the Atlantic in 2013, the world economy is expected to perform better this year.
That optimism is rejuvenating interest in other assets, such as equities. According to Lipper, net flows to U.S.-based equity funds in the first two weeks of 2013 were, at $11.3 billion, the biggest fortnightly inflow since April 2000.
Commodity fund managers said this month that they currently favour industrial metals such as copper and iron ore, as well as platinum and palladium, over gold.
"People are trying to understand whether we're in a recovery scenario, or whether there is another speed bump out there," Clive Burstow, a fund manager at Baring Asset Management, said.
"I think you have to have an exposure to gold, because there are still headwinds ... but you don't need as big an exposure as you did when you thought the world was ending."
Burstow said he will probably trim his fund's exposure to gold over the next year.
Neil Gregson, manager of the J.P. Morgan Natural Resources Fund, still sees solid support for gold prices but said that he expects to hold or even reduce his fund's holdings.
"Our investments have already gone down on the gold side," Gregson said, estimating the fund's exposure to gold at about 24 percent, against 30 percent this time last year.
"It's still a significant part of our portfolio, but looking at other miners, such as copper and iron ore, we think there are more opportunities there compared with gold."
The price of gold was driven sharply higher as monetary authorities around the world fought to stave off the worst effects of the financial crisis by dropping interest rates and flooding their economies with cheap money.
That benefited gold by boosting its appeal as a safe store of value and a hedge against inflation.
Gold's positive reaction to quantitative easing (QE) - essentially the injection of more cash into a country's economy by its central bank - has become shorter and shallower with each round. During the United States' first round of QE, from November 2008 to March 2010, gold rose more than 30 percent.
Since the Federal Reserve unveiled its third round of QE in September, an open-ended scheme to buy $45 billion a month in mortgage-backed securities, prices have fallen nearly 4 percent.
Expectations are also starting to emerge that the Fed's QE may be drawing to a close. "There is a greater chance today than there was last year that we might start to see QE being less prevalent," BlackRock fund manager Evy Hambro said. "But the great concern for the U.S. economy is not to do it too soon."
One of the reasons why QE is considered good for gold is that it stokes fears of inflation. During periods of inflation gold is expected to hold its value while that of other assets is eroded.
Not everyone is convinced. In a note produced last month, which preceded a $40 drop in the gold price, HSBC Asset Allocation said that it preferred treasury inflation-protected securities as an inflation hedge.
"If you get inflation, provided you get a monetary response to it (in the form of) higher interest rates, that is the death knell for gold," J.P. Morgan's Gregson said. "The holding cost becomes very high when you can get 10-15 percent on your money because of higher interest rates."
There are still many positives for gold. None of the fund managers interviewed here believed that gold prices are set for a big correction, and all saw headwinds for the global economy which justified some allocation to gold.
Patrick Armstrong, at Armstrong Investment Managers, said that his fund had added a little more gold to its holdings in recent months after cutting exposure last year. His fund's allocation is currently 2.5 percent.
"We think gold would be a good hedge against the destruction of the purchasing power of most of the currencies of the emerging world," he said.
Neither the U.S. nor the euro zone are out of the woods yet. Data last week showed that the U.S. economy shrank unexpectedly in the fourth quarter of last year and European Central Bank President Mario Draghi said that the "positive contagion" on financial markets is not yet feeding into the economy at large.
Until better sentiment really begins to kick in, gold will remain in demand.
"We have a small weight in gold because we still think it makes sense to have a hedge against negative macroeconomic outcomes," Joost van Leenders, of BNP Paribas Investment Partners, said. "(But) it is a pretty long-term position. We are not that optimistic (on prices)."
(Additional reporting by Clara Denina; Editing by David Goodman)
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