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…
- Why did the price climb so much? Is there historical precedent?
- 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.
I 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).
The 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.