For many months now – perhaps even years – the fiscal regimes governing the world’s major currencies have been broadly pursuing very generous monetary policies. This means talking the currency down, setting very low (and in some cases even negative) rates of interest, and plenty of “quantitative easing) i.e. increasing the money supply and effectively printing money. It is often said that we are living in an era of cheap national currencies, backed by nothing more than debt, which is increasing everywhere exponentially.
If we hold all this to be true, then gold traders have to wonder why Gold, apparently an immutable store of value and the world’s only true store of value, has been trending downwards continuously for almost three years, as gold trading seems to be seeing a surfeit of traders wishing to buy gold. In case you are wondering if this is all about a strong U.S. dollar, which gold is traditionally priced in, then think again: the price of gold has been falling during this period in Euro terms too, and the Euro has certainly fallen over this period. Gold isn’t going up.
The fact that the gold spot price has plainly not been rising actually gives us an opportunity to re-evaluate what we think we know about how economic fundamentals affect the price of gold. We can look at each factor in turn.
The price of gold has not been rising because the market just isn’t scared enough, or booming enough.
Inflation
Although we are currently living in a world where national currencies are debased on a scale large enough to have given old-school monetarists nightmares, there is very little inflationary pressure within the current environment, at least so far. We are living in a rather strange climate, where interest rates are near zero or even negative, but inflation just refuses to come. It might be the case that it is inflation, and not an increase in the supply of fiat currency itself, that tends to cause the price of gold to rise. However, if this is so, then why was gold rocketing upwards in 2011, when there was also precious little inflation?
Fear of Debt Contagion
A key difference between recent months and 2011 is that there is far less fear of a catastrophic crisis of debt contagion than there was then, when the Eurozone appeared close to a debt meltdown. Although the Greek crisis again threatened major turbulence earlier this summer when a Greek exit from the EU looked probably and arguably even likely, the level of fear concerning the serviceability of national debts has been enormously reduced.
Gold as a Proxy for the Swiss Franc?
During most of 2011, there were two strong assets that were just begging to be bought: gold and the Swiss Franc. They seemed to move in tandem, both rising inexorably, and many analysts produced figures showing historically strong positive correlations between the two. With a significant proportion of the world’s gold bullion manufactured in Swiss refineries and located in Swiss vaults, it seemed like a logical conclusion to draw.
If this was a major factor, it ceased to be the case one day when the Swiss National Bank suddenly made in clear they were not going to sit idly by while their Franc appreciated endlessly. Most of Switzerland’s economy relies upon exports to drive prosperity, not bank deposits and financial services. The Swiss Franc has been trending down ever since, and when that trend began to be seriously threatened, the SNB forced another effective devaluation by uncoupling from the Euro peg and introducing a negative interest rate of three-quarters of a point. Although the Franc initially rose sharply, it now seems plausible that a devaluation was actually the final intention, after allowing the SNB to clear its positions at arguably fictitious prices, which were effectively the result of market manipulation by the SNB itself!
Softening Demand
It is often forgotten that there is plenty of real private demand for gold out there, whether for conversion into jewelry or as a store of value for individuals and families. Additionally, there are some industrial uses for gold, and much of the demand in both of these categories comes from emerging economies such as China and India. There are plenty of signs of less demand both globally, and within these two specific markets, as ongoing economic recoveries remain slight and sketchy. Gold shares, i.e. shares in gold mining companies, have also been in the doldrums.
Price Relativity
The price of gold really took off in 2005, and it doubled within the next few years, before more or less doubling again in a much shorter period of time. Once this kind of long-term momentum of a rising price becomes established in something that traditionally excites people as a store of value, such as gold, then the price rise takes on a life of its own. People become tempted to sell old jewelry and family heirlooms when they see the price rising strongly week after week. Such a trend attracts plenty of speculators too, who keep the trend going.
The price may rise from the gold rate today by another $1,000 per ounce. However apart from the hard-core gold bugs, who would believe it? It would take a few months of strong price rises to really take off.
The fluctuations in the price of gold, far more than most speculative instruments, remain shrouded in mystery for most of those not investing and trading gold, and for many of those who do!
Conclusion
The price of gold has not been rising because the market just isn’t scared enough, or booming enough. There needs to be more affluence or more fear of debt contagion or inflation to really give the price of gold a serious boost. Gold isn’t going up.