On Monday, gold futures fell 9.3 percent, the biggest one-day drop in 33 years. With two-day losses of 13 percent, gold’s steady decline since October 2012 has turned into an almost unprecedented rout.
Is there an explanation for this? You bet. Actually, there’s no shortage of explanations. The Wall Street Journal and Bloomberg Businessweek‘s Peter Coy point to lowered inflation expectations. Commodities brokers see a broad drop in metals driven by a weakening China. Goldman Sachs & Co. analysts, who presciently cut their gold forecasts last week, cite fears that central banks will cut their gold reserves. If you want more, John Cassidy has a list over at the New Yorker.
All of the explanations of why gold has fallen come on the heels of many recent predictions that gold was set for a rebound. Witness, for instance, the way-off-base forecasts from Merrill Lynch’s technical analyst in February. The gyrations of the gold market have proven themselves to be impervious to analysis. As JPMorgan Chase & Co. economist Joseph Lupton put it to Businessweek, “Gold is an animal unto itself.”
Indeed. When gold is going up, any explanation will do to explain the advance: a world economy in crisis, central banks printing money. And when it goes down, suddenly a slowing economy in China explains the drop.
The deeper issue here is that the most common explanation for gold’s ascent — that it’s a hedge against inflation and monetary debasement — hasn’t held water for a long time. That explanations seems to reflect a belief built up some 30 or 40 years ago. From 1973 to 1980, a period in which inflation was generally over 6 percent in the U.S., gold skyrocketed.
What happened next is worth looking back to. Gold plummeted in 1981, a year in which prices rose 8.9 percent. Notably it fell right through the very sharp recession of late 1981 and early 1982. It offered no particular protection against either rising pricing or economic contraction. Much the same is turning out to be the case now.
As gold has risen through a period of low inflation, the notion that gold is a “hedge against inflation” has been replaced with the more general thesis that “gold is a hedge against economic uncertainty.” The last days have blown that up. Nothing has happened to reduce the world’s economic uncertainty. You might think that the Cypriot crisis would have shaken investors’ confidence in other currencies enough to send gold up. It hasn’t. The New Yorker‘s Cassidy calls the price of gold a “fear index.” That’s true: Gold rises in periods of turmoil. But the link between the price of gold and real economic conditions is weak. Investors who one moment see a world economic panic and rush into gold can as another moment see a gold panic and rush for the exits.
Now, after the collapse of the last few days, there doesn’t seem to be any more reason to think that gold is a hedge against anything. If your aim is to protect against erratic and unpredictable turns in the world economy, gold seems like the last instrument for doing so. The exception may be if you think that we’re in for a worldwide apocalypse in which nations and currencies disappear. If we are, yes, gold could well rise in value, though shelf-stable canned meat is likely to rise more.
Above, a chart of the recent performance of canned fruits and vegetables (I couldn’t find canned meat at the Bureau of Labor Statistics) versus the inflation rate. As you can see, in the last years of economic dislocation you would have done fairly well stockpiling canned goods, nicely beating inflation, as well as many other asset classes. Over the long haul, that’s not such a great investment.
Investors in gold seem to fall into two categories. On the one hand are those, like George Soros, who believe that the last few years of gold prices reflect a speculative bubble — which they’ve been happy to ride. On the other end of the spectrum are those, like John Paulson, are those who believe that gold is a reliable store of value in a period of monetary debasement. Notably, Paulson, in the second camp, is still heavily invested in gold as it falls, while Soros seems to have largely gotten out.