Archive for October, 2008
Gold has fallen more than $300 – about 30% – from its all-time high of US$1034 last March to its recent lows near $720. And, since the beginning of the year, it is off about 12% – not too bad compared to most other asset classes. Looking at the decline of the past week, most analysts are saying that gold has been pulled down by the drop in oil, the strong U.S. dollar, and an easing of inflation expectations.
But, in my view, gold’s latest swift decent is a direct consequence of the unfolding global economic situation, the playing out of the credit crisis, and the onset of recession. The yellow metal was simply overwhelmed by the massive indiscriminate liquidation of financial assets and commodities – liquidation prompted by the reassessment of global economic prospects and the likely diminishing demand for one commodity after another.
To a large extent, gold was sold because the yellow metal is included in several important indexed baskets of commodities that have been liquidated en masse by hedge funds and institutional traders.
In addition, negative momentum, automatic program selling, and technical trading has compounded the damage. And, though probably not a factor in the past few days, increased central bank gold lending (as detailed in our last Gold Brief and in the adjacent article) has contributed greatly to gold-price weakness in recent weeks.
Does this mean that gold is suddenly no longer a safe haven in turbulent times . . . or a hedge against inflation . . . or a useful portfolio diversifier? Of course not — but it does demonstrate that at times of panic even the yellow metal can fall victim to developments in other asset markets.
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Our last Gold Brief (Gold Plunges – What’s Going On, October 16) generated much interest and questions about the mechanics of gold lending. In that piece, we suggested the recent breakdown in the price of gold was much more a reflection of stepped up central bank lending of gold — and much less a result of actual central bank gold sales or liquidation of long futures positions by hedge funds and other large-scale speculators, both of which seem to have grabbed all of the credit among gold analysts and the financial press.
Central banks, eager to earn a small return on their official reserve holdings, have long been lenders of gold. However, the ownership of gold lent to (or on deposit with) bullion banks remains with the central bank lender. Thus, gold-lending activities are off the books and gold lent continues to be counted by the lender as official monetary reserves. Hence, there is no statistical reporting by any of the central banks engaged in gold lending – and analysts are, like Sherlock Holmes, left to deduce this important piece of the gold-market puzzle.
It is my firm conviction that gold loans to bullion banks in recent weeks and months have been an off-balance sheet tool utilized by some central banks to augment their efforts to provide liquidity to the banking system — since gold lent (placed on deposit) is sold for cash and typically reinvested in U.S. Treasure bills or other securities by the bullion bank/gold dealer.
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Why was gold down so sharply today — in the face reportedly record demand from investors for bullion coins and small bars?
News that European central banks sold 7.6 tons of gold in the week ending October 10th has certainly been a heavy burden on the price and helps explain why the metal could not move higher last week and, if selling has continued, in the past few days.
But, it has been central bank gold loans — even more so than official gold sales — that has really pulled the rug out from under gold. Gold loans by central banks are an alternative — and invisible — means of injecting liquidity into the banking system.  These gold loans to banks and bullion dealers by the leading central banks are probably a significant multiple of outright official sales.
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Here’s a summary of what we’ve been saying in the past week about gold and the world macroeconomic picture:
- The idea that the U.S. dollar is suddenly stronger in recent weeks is a foolish notion. Rather, gold is telling us that currencies, across the board, are weaker — only the dollar a little less so than the euro, the UK pound, and other key currencies around the world. In fact, as finance ministers and monetary authorities in the euro-zone continue to fiddle, longer-term economic and political cohesion becomes increasingly questionable. In my view, the euro is just beginning a long and protracted fall — but this should not be mistaken as an indicator of a strong and healthy U.S. dollar.
- Gold is continuing to “de-link” from the rising dollar and falling price of oil as fear drives investors to the safe haven of gold. This is testimony to gold’s unique qualities as a monetary asset like none other, an asset that is not another’s liability and dependent upon the financial strength of the issuer.
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