GOLD: Seeing Past the Sell-Off (October 23, 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.
I’m no gold bug, but I’m not willing to give up on the yellow metal’s extremely bullish longer-term prospects, prospects that are just as bright – if not brighter – today as they were earlier in the year when gold pierced a $1,000 an ounce.
Nevertheless, in the near term, gold remains vulnerable to the same forces that knocked the metal’s price down from over $800 an ounce. It is easy to imagine, in the wink of an eye, gold at $700 – or even less – before the yellow metal begins to shine once again.
This past week, as in recent months, we’ve seen strong physical demand from ordinary investors and savers – from billionaires to middle class folks like “Joe, the Plumber” – all driven by fear, rushing for the safety and protection historically offered by gold. This is a global phenomenon as retail outlets, coin fabricators, and refiners report a rush of demand around the world for bullion coins, small bars, and investment-grade jewelry.
Importantly, today’s buyers are not traders looking for quick gains but scared people seeking to protect their wealth, their savings, and their retirement nest eggs. Somehow, I don’t think they are all wrong and the wizards of Wall Street who are selling gold are all right! Rather, this wave of gold interest is a harbinger of gold’s ultimate ascent.
I remain bullish on gold because, in the end, as the global economic recession deepens, governments will find the only way out of this mess — the only way to pay for all the private debt it is accumulating — is to print more money. In other words, to inflate.
Reflationary policies, the injection of liquidity into the world financial system, and the historically unparalleled creation of money should soon begin to benefit gold once the current selling of financial assets and commodities runs its course.
As sure as day follows night, reflationary monetary policies — however prudent and necessary — have long-term implications for global inflation. Typically, monetary creation affects price inflation with a lag of six months to a couple of years – so it may be some time before inflation is recognized as a serious problem. But gold prices have shorter lags and should begin moving up much sooner.
Don’t’ be surprised if gold’s upward ascent is just as fast and furious as has been it’s recent decline. If anything, gold promises to remain volatile – both up and down.
In addition, gold should benefit from seasonal buying in the fourth quarter, typically a time of good cheer for gold investors. In the West, it’s Christmas gifting, in India – the world’s biggest gold consuming country – it’s wedding season with dowries of gold jewelry, and in the Middle East it is also a time of holiday-related buying.
Gold-price prospects remain as bright as ever — and nothing in the recent market performance has changed our forecast of record high prices in the next few years. For the near term, I still expect to see gold back over $1000, if not by late this year, then almost certainly in the first quarter of 2009.
