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.