Why the price of gold skyrocketed and why it’s over!

I Loooove Goooold!Everyone is fascinated by the yellow metal.  I’ve been to exploration sites as far north as Nunavut (by the Arctic Ocean) and south to operating mines in Chile.  But determining what it’s worth remains a conundrum to all of us.

The price of gold peaked in November at about $1750 per ounce, but has declined to nearly $1630 in past weeks.  A loss of -6% to -7% is hard to stomach in this market environment.  There are two things I’d like to address in this rant…

  1. Why did the price climb so much? Is there historical precedent?
  2. Where does the price go from here?

Ten years ago when I began writing my book Resources Rock (Insomniac Press, 2004) gold was so cheap it tingled my ‘deep value’ senses.

gold to Jan-13I wish I’d sold my house, motorcycles and guitars and just bought some of the stuff – but this is just the sort of “would’ve should’ve could’ve” wishful thinking that torments portfolio managers 24 hours a day until the end-of-days.  The good news is I did launch and manage a resources-oriented mutual fund which made serious money for clients with the gumption (or they were just not strong enough to withstand my outstanding salesmanship?) to buy into a universally hated (at that time) sector.

Frankly, I did not expect the price to continue to rally over the most recent 3 to 4 years.  Our brains develop biases based on experience, and my experience is long.  I’ve always watched (and bet on) the gold price firming during periods of rising interest rates. They can be rising because inflation expectations are rising, or simply because the economy is strong (improving demand for credit).

Gold versus 6M TbillsThe chart I whipped up shows the yield on 6-month US Treasuries (blue line) compared to the percentage change in the price of gold annually since 1960.  I believe it illustrates the pattern I grew accustomed to.  I selected the shorter term US Treasury yields as my interest rate proxy since they used to respond quickly to changes in inflation expectations.

Taking a few minutes to reflect (if I think too long my mind wanders….a symptom of adulthood) I see what might be an explanation for my getting it so wrong.

I neglected to take into account two important factors.

  • Changes in the way government manages monetary policy
  • The ‘end-of-the-world’ effect

At the end of World War II for example, the thinking of policy-makers was print money and spend it to get things moving.  Nowadays we believe all that approach accomplished was creating too much government, so instead the government just buys back debt that won’t be paid which creates liquidity and hope the money is spent on activity that fuels growth in the private sector.

A byproduct of the new mindset is ridiculously low interest rates, and uncertainty.  Uncertainty because we have no idea if the liquidity will be spent (will there be a mulitiplier effect?) and translate into growth and price inflation; or will it be hoarded (continuing risk of deflation and stagnant economy).

Why did the price climb so much? Is there historical precedent?

If the consensus was that blatantly stimulative government policy would soon create inflation and economic recovery then the price of gold should have risen.  But if the consensus believed stagnation and deflation was going to be pervasive, bonds alone would be the place to be and there’s no reason for the price of gold to climb…..UNLESS….investors today have no confidence in the “new” program, and don’t believe paper assets are worth the paper they’re printed on……i.e. the “end-of-the-world” effect.  I am not familiar with any historical precedent since the dropping of the gold standard.

Where does the price go from here?

As (or should I say if) the “end-of-the-world” scenario grows less likely in the minds of investors, there will be an awful lot of sellers of gold and related securities.  Get ready to see the price fall to $1000 or less.

As always, gold will be a good place to be after the fear fluff has been kicked out of the price or in other words when it’s once again the last place you want to be.  Then a growing economy and gradually rising interest rates (and modestly increasing inflation expectations) will be a friendly climate for the gold buff once again.DSC_0102

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About Mal Spooner

Malvin Spooner is a veteran money manager, former CEO of award-winning investment fund management boutique he founded. He recently authored A Maverick Investor's Guidebook which blends his experience touring across the heartland in the United States with valuable investing tips and stories. He has been quoted and published for many years in business journals, newspapers and has been featured on many television programs over his career. An avid motorcycle enthusiast, and known across Canada as a part-time musician performing rock ‘n’ roll for charity, Mal is known for his candour and non-traditional (‘maverick’) thinking when discussing financial markets. His previous book published by Insomniac Press — Resources Rock: How to Invest in the Next Global Boom in Natural Resources which he authored with Pamela Clark — predicted the resources boom back in early 2004.
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11 Responses to Why the price of gold skyrocketed and why it’s over!

  1. ray steele says:

    And the $1 trillion coin the treasury may issue is platinum.

    Sent from my iPhone

    • Ashakir says:

      Its funny how we all predict gold crash time and again but are yet to see signs of one…

      I believe Gold has re-emerged as an asset class for Central Banks to hold on to protect against unforeseen.. 5-6 years back CBs were net sellers of Gold, but the characteristic of recent crisis (a kind of systematic failure without historic precedence) have made Gold as an important reserve asset to Hold.

      Although i do agree that signs of economic recovery will bring about decline in gold prices, a level of up to 1,000 is a bit too far stretched. The lesson this crisis has taught us is the importance of having yellow metal in our investment portfolio. 20-30 years gold history is not relevant for gold prices in comparison to the last 10-15 years since the global landscape is a lot different than what we witnessed in 80s-90s…

      • Mal Spooner says:

        The behavior of central banks is well documented. If i am right, Only after gold falls to 1200 (to randomly pick a number) then they will begin selling and drive the price down further. They always sell low and buy high.

  2. Mad Dog says:

    Gold is just the inverse of the US buck. There is no reason to believe that trillion $ cash infusions from the Fed’s QE Infinity or an increasingly taxed and regulated statist economy are going to add strength to the dollar (chorus: Don’t Cry for Me, Argentina!). I would, therefore, be ‘all-in’ in gold except for one thing: the Bakken and other shale deposits. The US is on the road energy self-sufficiency. Oil imports are dropping quickly. The Fruited Plain’s economy now has some asset backing (apart from big-box superstores), and, over the next few years, their currency could start to morph to a petro currency (like the Beaver buck). This may save the US, and Obama and company may come out smelling like roses. So, I’m still uncertain as to how this will play out in 5 to 10 years. One thing, though: I won’t be holding any energy companies with a stake in high-cost oil sands.

    Cheers, and Happy 2013!

  3. Paul Bernard says:

    Maybe one is overlooking the “end of the world” definition. Gold is still perceived by increasing many as the only safe currency after the sick US dollar, and the worst Euro currency. Market volatility in the last 5 years created investors’ need for a stable environment, particularly with the beginning of baby-boomers’ retirement. This will get worst, that is, this insane need for stability and its insane counterpart to avoid “risk”. And risk is what drives growth. Gold was the underlying currency until things got out of control, until some illuminated scholar saw the need to print paper as “legal tender”. This gave the governments the legal authority to spend without restriction, as long as paper was available, not gold. Many are now regretting and believe the rational thing to do is to go back to gold standard. The good old days they say. Well, there is not enough gold to support today”s monetary system. Going back to a gold standard is committing to many decades of deleveraging, and many decades of increasing poverty. Politics will try to avoid it, thus many years of decreasing US currency value. The US government, whatever orientation, will not take the hard decision. Three cheers for Gold, Hip, Hip!

    • Mal Spooner says:

      Paul: You may be right. One theoretical issue the gold bulls
      miss is that the $US is a price relative to other currencies. If gold is a currency (I don’t know that it is) in fixed supply then yes it will climb relative to the buck. If it is a block of metal that looks pretty, then food and beer might become more valuable as currency if the financial system does collapse.

  4. Adam Adamou says:

    I’m in the gold is a currency camp.

  5. jose b says:

    Mal’s comment reminds me the (Gordon) Brown bottom and Andy Smith’s well known prediction of $100/oz gold. They are the jokers of the century. Gold is the ultimate money not commodity. Yes, you can make that $trillion coin, a kiss death of fiat currency, right?

  6. Pingback: Tempted to buy gold? Better to be patient! | Maverick Investors Rally Site

  7. Pingback: Be Long Gold Now; Switch To Silver Later | Prompto Capital

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