Many of the most cherished hopes of gold bugs have come true
in the past few months but not, alas, the only one that
matters to them in the end: a sharp rise in the price to bring
it back into record-breaking territory.
The Comex front-month futures contract for gold peaked just
shy of $1,800 an ounce in early October before dropping again,
defying bulls hopes that it would rise above the 2011
peak of $1,912. In Mondays New York lunchtime trading it
was $1,730. Should its flat recent performance make
institutional investors wary of its luster in the future?
The run of favorable news for gold bugs began in August when
Mario Draghi, president of the European Central Bank (ECB),
stoked inflationary fears by outlining his outright monetary
transactions program to buy the sovereign bonds of troubled
member states where necessary. Federal Reserve chairman Ben
Bernankes September announcement of a third round of
quantitative easing (QE3) an injection of another $40
billion into the economy each month added inflationary
pressure to the U.S. economy.
The reelection of Barack Obama as U.S. president on November
6 provided further impetus for gold, by increasing the chances
that Bernanke can continue with ultra-loose monetary policy for
longer. Mitt Romney, the Republican challenger and a
monetary-policy hawk in comparison with Obama, was set to
replace Bernanke with an inflation hawk after the
chairmans term in office expired in January 2014.
These three factors boosted gold but not as much as
bulls had hoped, given past surges in the price in response to
signs that inflation might dilute the real value of the dollar
and the euro.
One argument for golds rather muted rally is that
while potentially inflationary news from the developed world
was boosting the yellow metal, the fundamentals for gold were
poor in China. Last year the Middle Kingdom was judged to have
altered the market forever by overtaking India to become the
worlds largest consumer of gold. However, demand from
China fell at its fastest year-over-year rate since 2003 in the
third quarter, hit by a retreat in inflationary fears: Chinese
consumer price inflation dropped to only 1.9 percent in
September, down from a high of 6.5 percent in 2011.
Nevertheless, it is likely that inflation fears will stalk
China again before long, since the countrys economic
slowdown is proving short-lived.
Worrisome for gold nonetheless is a growing sense that, like
a teenager with an identity crisis, its behavior is becoming
Historically, the metal has risen partly in response to
inflationary fears, because of its 4,000-year-old pedigree as a
store of value. However, it has also risen during times of risk
aversion in capital markets those times when
institutional investors have a powerful sense of impending
catastrophe, even if the nature of the catastrophe is not
necessarily inflationary. The explanation for golds rise
during crises of every shape and hue is as circular as a gold
ring, but none the less powerful for that: investors buy gold
in the assurance that it will rise during a crisis, and it
rises because investors always buy gold during a crisis.
A problem for gold is that this circular argument has
recently broken down.
The looming U.S. fiscal cliff the tax increases and
spending cuts due to come into effect in January unless
politicians strike a deal has the same timbre as other
fiscal crises in other major economies which have boosted gold
purchases in the past (though the effect of going over the
cliff would be deflationary). However, Edel Tully, precious
metals strategist at UBS in London, notes: The
expectation of political posturing surrounding the fiscal cliff
is not [yet] providing the ingredient for the next rush of
buying. Tully argues that some of this correlation stems
from golds still positive correlation with
risk. She concludes, Quite clearly gold hasnt
separated itself enough from the risk crowd.
This view is supported by statistical research from HSBC,
which shows that gold has been moderately positively correlated
with risk-on assets over the past 20 weeks.
Nomura remains bullish about gold forecasting a price
of $2,100 at the end of next year, because of loose monetary
policy. However, it notes: We acknowledge that
golds correlation to risk can be variable. It is,
in other words, not reliable a risk-off asset at the
Many analysts credit the new link between gold and risk-on
assets to the increasingly cross-asset nature of investment.
Macro funds are buying the full gamut of different assets,
including equities and commodities. At moments of market panic
when most asset prices are falling, they find themselves forced
to meet funding needs by selling classic risk-off investments
such as gold on the same days as classic risk-on investments
such as equities. Partly because of this trend, in terms of
short-term, day-to-day trading, golds safe-haven status
has become tenuous indeed.
But although golds recent daily unpredictability
counts against it, it may yet be saved by the long-term
unpredictability of global financial systems.
The low inflation that prevailed in developed economies for
much of the 1990s and 2000s appeared to sound the death knell
for gold. Much of the price stability can be credited to the
relative independence given to central banks, which remained
largely free from government pressure to cut rates to meet
Over the coming years, however, the temptation among
governments to interfere in central banks operations in
order to encourage higher inflation may become irresistible, as
they try to inflate away their high debts.
It may not even require much government interference before
central banks start pursuing more inflationary policies.
Announcing QE3 in September, Bernanke said he would continue
pumping money into the economy until the labor market improved.
Many analysts think the neutral unemployment rate
in the U.S. the rate below which inflation starts to
build up because of skills shortages has risen in recent
years. If true, that means the inflationary price tag for
improving the labor market will be higher than before a
promising scenario for gold, at least in the traditional