Q: Gold has fallen in price. Is it time to buy?
A. Probably not. Despite the recent swoon, it's hard to envision a scenario under which the mystical metal recovers its former luster in the immediate future. Given the absence of imminent inflationary pressure, the specter of reduced central bank stimulus next year, and the potential for a stronger dollar in the face of global weakening, none of the traditional arguments for gold currently hold, unless you just like shiny objects.
Given the carnage, it might be tempting. Since making an all-time high of $1,895 per ounce in 2011, gold has plummeted to $1,180 as of last week, a decline of 38 percent, while the second quarter alone produced a 23 percent drop, the steepest quarterly decline since records have been kept. But the forces propelling that decline remain in effect and will likely prevail for some time, implying that gold may still be a falling knife. Attempt to catch it at your peril.
Although gold has been used as money since time immemorial (along with beads, salt and cattle), allowing the price to float is a modern development. Gold prices in the United States were historically set by the government. Technically, the dollar was pegged to a certain quantity of gold, and the currency was theoretically freely exchangeable at will into specie until 1933. After World War II, the Bretton Woods agreement reset the price of gold at $35 per ounce (actually fixing the value of a dollar at 1/35 of an ounce of gold). Since most other countries pegged their currencies to the dollar, the world gold price was effectively determined by the U.S. government.
After the war, the U.S. experienced growing trade and balance of payments deficits as consumers emerged from wartime rationing and suburban sprawl exploded. These trade imbalances imposed untenable burdens on our trading partners, and eventually led to the abolition of the gold standard in 1971. Henceforth individuals could buy gold again, at a price determined by the market.
By 1980, the price had soared above $650 per ounce; equivalent to $1,826 in today's dollars. Ironically, this is very close to the recent high, but under very different conditions.
When real gold prices peaked in 1980, the U.S. was mired in a recession, inflation was screaming at 13.6 percent, and the Fed raised interest rates to 20 percent. Fast forward to 2013: inflation at 2 percent, Fed Funds at zero, and four years of economic growth. Furthermore, the threat of currency debasement over which so many gold bugs have fulminated is nowhere to be found. The world today is a very different place.
In 1980, half of the global demand for the precious metal came from investors seeking shelter from the inflationary storm. Today, 60 percent of gold production goes into jewelry and industrial manufacturing, mostly in India and China. Gold is less about the demise of the dollar and more a bet on the nascent Asian middle-class. It may be too early to take that bet.
Christopher A. Hopkins CFA, is a vice president at Barnett & Co.
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