After The Gold Rush

On Monday, gold prices hit a recent low of $1532.72, roughly 20% below this months high of $1923.70. Last week proved to be the most difficult so far this month for gold which was strange given that stocks also dropped heavily. Gold which is considered a safe haven, normally trends in the opposite direction of risky assets like equities. So why did gold drop last week? I asked Chester Ntonifor, a commodity analyst, and he provided this insightful answer:

“Too much of a good thing” partly explains why gold prices fell as global investors sought shelter from risky assets. Speculators were loaded with the yellow metal as they embraced the idea that fiat money debasement, falling real interest rates and careless fiscal policies were fertile ground for rising gold prices. Last week’s panic selloff, exacerbated by higher margin requirements, triggered gold margin calls and a colossal liquidation from these frothy investors.

The second reason gold prices fell carries similarities with 2008. During times of severe financial stress like 2008, U.S. treasurys are still considered the ultimate safe-haven. A flee into U.S. assets causes the dollar to spike. This is negative for gold, since a rising dollar lowers the quantity of gold you can get for the same unit of foreign currency.

Going forward, the path for gold prices will depend on the policy response. Unconventional policy stimulus will be positive for gold. However, extreme financial stress would be negative, since that would be associated with U.S. capital repatriation and a dollar spike.

Gold Price Factors

When S&P downgraded the rating on US treasury bonds recently, investors sought two safe havens from the perceived risk resulting from the downgrade. Ironically, the first safe haven was treausuries themselves and the second was gold. Of both asset classes, gold gained the most, rallying for the 7th straight week to 1880 dollars per ounce.

Which of the factors discussed on our song Gold Price Factors is driving the price this time, you might be asking yourself.

1. Flight to safety is the greatest driver of gold prices lately.

The fear of a double dip recession combined with the S&P downgrade and european bank/sovereign debt issues has driven investors into the perceived safety of gold.

“Flights to safety increasing the net worth
Of precious metals we’re mining from the earth
Its store of value calms investors fears
From sudden panics that bring our brokers tears”

2. Easy monetary policy

To help stop the downward spiral of equity prices last week, Bernanke promised to keep the overnight interest rate at roughly 0% until the middle of 2013. This could have contributed as well to the rise in gold prices.

“Watch Ben Bernanke and soon you’ll understand
How easy money gives gold greater demand
Commodity prices trend in the inverse
Of fiat values supply becomes a curse”

When I spoke to David Rosenberg about the global economy last month, he noted that gold has been trading more and more like a currency and less like a commodity. Gold is rising on the fear the central banks are destroying the credibility of fiat currencies with excessively low interest rates and quantitative easing thus making gold a better store of value than dollars.