Gold has enjoyed a classic decade-long bull run, the first seven years of which were characterized by supportive supply/demand fundamentals and the last three years have enjoyed augmented growth (roughly doubling the rate of price increase) based around gold's role as a safe haven.
It could be said that gold has behaved with aplomb and does precisely what it should do. Firstly it has behaved as a bellwether, providing the clearest signals when financial markets and economies have gone awry and secondly it has provided a lifeboat in a crisis for those seeking wealth preservation. With an annual price increase of 28% in both 2009 and 2010 followed by a rise to an all-time of $1,920 earlier this month – a gain of 34% YTD. In 2011 the market looked set for further price gains as the economic gloom deepened. So far, so good.
But in the last few days, the so-called fear index or VIX index has again rallied over 40 (it has only done so 5 times in the last 30 years) as the financial markets edged to a new level of crisis gold slumped and gave back about 12% of its annual rise. Whatever happened to the canary in the (gold) mine and its much vaunted role as a safe haven asset?
The answer is complex. Firstly, the dollar has strengthened significantly – not because it is in anyway attractive per se, but more a case of being the least unattractive currency, especially since the Swiss Franc fell off the catwalk. Being dollar-denominated, a strong dollar makes gold expensive outside of the U.S. and consequently gold falls. The unintended consequence of Europe looking so poor is that the dollar has gained in value which is ironic as it is probably the very last thing which U.S. exporters need as they try to fire up their own manufacturing capabilities.
Since the end of August the dollar index has risen to a six month high against a basket of currencies, up 20% against the Brazilian Real for example. The Euro, by contrast, is off 7.2%. The second reason for gold's current weakness is 'death by association'. The industrial metals such as silver, platinum and copper are all sharply lower (copper lost 12% yesterday) simply because of weaker prospects for economic growth. Many of these metals are traded in indices such as the GSCI which also contain gold; so, despite quite divergent outlooks, gold has suffered alongside its sister-metals. Thirdly gold is said to have been sold-off in the face of equity weakness where highly profitable positions in gold have seen profit-taking to fund margin calls in equities. Lastly, the technical analysts will be saying we told you so. Much of gold's rise this year took place in August and it was on the charts both looking overbought and forming a bearish 'double top' formation - a retracement of some sort was in order.
It may be little comfort to gold bugs but has actually fared better than most other asset classes.
Looking ahead, it will be very interesting to see how gold responds – many investors have craved a buying opportunity (particularly Indian traders) and the recent fall creates a monumental window of opportunity to get in on gold. On the other hand price volatility of this sort is typically deeply destructive to investor confidence. It remains to be seen which motive will win out between the two. Gold has for much of this year faced adversity by quickly making up on the losses and moving ahead - showing it had strength in depth – it remains to be seen if it will continue in this fashion. It certainly feels as though a price floor is being established.
As the economic ping-pong match swings back to Europe from the USA (for the most depressing headlines), gold market watchers will have their eyes on developments vis a vis Greece, the Italian long dated bond yields, retail demand for gold and lastly but not leastly, the most important thing that all financial markets crave. And that is some sense that politicians are prepared to take bold policy decisions on the economies. Were they to fail on this task and to achieve some consensus for those actions, then that way Trade War lie which will almost certainly lead us all into a depression of 1930's proportions - with unthinkable consequences. As we head into the weekend lets hope and give support to positive action.
Ross Norman is the owner and chief executive officer of the London-based gold broker Sharps Pixley Ltd.