The sharp fall in the price of gold in recent days took many investors and analysts by surprise. I’ll admit that the plunge in the prices for precious metals was surprising, and I didn’t think gold would fall so promptly.
Nonetheless, I thought the price of gold would have started its descent when the market adjusts to the Fed’s change in monetary policy (assuming it will change it in the near future). Based on the recent developments in the gold market, does this mean gold will keep falling from its current level? Is the golden era of gold behind us?
Gold as a safe haven
The notion of gold as a safe haven may have started after the Fed began its first quantitative easing plan back in 2008. Moreover, the weakness in the equity market (on account of the financial meltdown in 2008) and low long-term yields of U.S. Treasuries pushed investors toward gold.
I think another driving force may have been speculation of many investors that the U.S will eventually go back to the gold standard. In case you think this might be a good idea, just look at the Euro area – this region has the Euro as its own type of gold-standard currency.
Economist Paul Krugman made this comparison. Basically, the Euro-area countries aren’t able to print money (even though the ECB has this possibility). This puts Euro-area countries, such as Spain and Italy, in a situation where they can’t print money even if they need it to jump start their economies. This is a fair comparison that proves why going back to the gold standard is a bad idea.
Is there a reason for concern?
In the past few years, the U.S equity markets recovered; the Fed’s plan to cut long-term yields with its asset-purchase programs helped steer investors away from government bonds and into equities. U.S. inflation remained contained at less than 2%. This reduced the concerns investors might have had about a sharp rise in inflation even further.
The U.S dollar remained relatively strong against leading currencies, such as the euro, yen and Canadian dollar: the decision by the Bank of Japan to augment its asset-purchase program drove the yen sharply lower, which made the U.S. dollar strong. Meanwhile, the debt crisis in Europe kept the Euro weak against the U.S. dollar.
Even though the U.S economy has shown some signs of recovery, it’s still too soon to claim that the Fed’s asset-purchase program made any difference. Moreover, if the U.S government continues to cut its budget, U.S economic growth might change course and contract.
Gold as an investment
The main problem with gold is that it only has the potential to appreciate over time as a return. When gold prices aren’t rising, the metal becomes less attractive as an investment. The sharp fall in gold’s price by more than 12% since the beginning of the month also pulled down the ETF SPDR Gold Trust (ETF) (NYSEMKT:GLD) Shares. The ETF lost 16.3% of its value so far in April.
Moreover, the ETF keeps losing ground as its holdings continue to dwindle. Since the beginning of 2013, the ETF’s gold hoards fell by 16%. This ETF follows the price of gold, and thus if the price of gold will continue to dwindle, the ETF’s price will also decline.
Moreover, the linear correlation between the monthly changes in the SPDR Gold Trust (ETF) (NYSEMKT:GLD)’s gold holdings and the price of gold is mid-strong and positive, and stands at 0.52. This strong correlation isn’t surprising and means the direction of gold price affects demand in this ETF.
Other gold-related investments similarly took hits: shares of royalty company Royal Gold, Inc USA) (NASDAQ:RGLD) lost more than 36% in value since the beginning of the year. Shares of the gold producer Goldcorp Inc. (USA) (NYSE:GG) tumbled 24%.
