Writing about a volatile commodity price always runs the risk of having the markets make nonsense of anything one says by the time the piece is published. However, the awesome rise of the price of gold, which is on a 21 month tear and has been tumbling one record high after another since it went through $1290 on Wednesday 22 September, is worth commenting on in and of itself.
The explanations being given for this are many and various, mostly having to do either with the weakness in the US dollar (which boosts dollar denominated commodities like gold) or with investor disquiet in the face of mixed economic signals, or with some combination of the two. However, there has been no shortage of additional and or deeper analysis.
Back in October 2009, a website, Longwave - whose name favours the cycle theories of the Russian economist Kondratieff, who gave his name to the theory of the Kondratieff 50 year economic boom and bust cycle (well worth Googling if you have never heard of it) - pointed out that with US Treasury Bill yields at zero, for all intents and purposes, there is no opportunity cost for investors in going into gold. It’s not as if they could earn five percent on their cash, and if you are scared of the volatility in equities then a rising gold market looks like a no-brainer.
However, the perplexing part of all this is that despite investor suspicions about helicopter Ben Bernanke’s fondness for rolling the printing presses and monetising the US debt, economists around the world are pretty much united in believing that the biggest risk to the US economy in the short term is deflation, not inflation.
Gold works as a value hedge against rampant inflation. With deflation the picture is much more uncertain, and most commentators would anticipate a sharp flow of capital out of gold in the early stages of a deflationary slide. This should be making gold look very overbought, but investor appetite says differently. So what else is sustaining gold?
After China’s intervention in the base metals market, swooping in to buy a three year store of copper in 2008 at a time when copper prices were arguably undervalued, every time there is a solid and rather opaque rise in the price of a metal people look to see if they can spot a fistful of large, well laden cargo vessels heading for China with the swag. China has said quite openly that it intends to increase its holdings of gold so that theory holds up. India too, is buying more gold to hoard. So that accounts for some large scale price pumping intervention.
However, the biggest change is undoubtedly the role played by ever increasing popularity of gold ETFs (Exchange Traded Funds), which give the retail investor instant access to bullion and which come in all sorts of flavours, from gold shorting ETFs, to long gold ETFs, to leveraged gold ETFs (where you get your profits/losses multipled 2x or 3x times). The ETFs have created a ready channel down which large volumes of money can pour into gold at a moment’s notice. (Of course, what pours in could also pour out, and the gold price can correct downwards at speeds reminiscent of May’s “flash crash”.)
On top of all of this, one rather different answer to the persistent strength of gold in the face of what looks like deflationary possibilities in the US is suggested by Arun Motianey, Director of Fixed-Income Strategy at Roubini Global Economics (RGE). I recently interviewed him for a forthcoming article in IPE. His view was that the continued rise in the price of gold becomes a lot more rational if you widen your gaze to look not just at the US dollar, but at the whole dollar “block”, including all those emerging economies in Asia and the Middle East who are still pegged, in one way or another, to the dollar. Many of their economies are grappling with inflation that is either in or not far off double digit levels. The pseudo exchange rate that underlies all of this is experiencing a crisis and that crisis is translating into the price of gold. As he puts it, extreme US centrism, which is how the dollar/gold debate plays out, is not the right lens with which to look at world inflation. If you view the whole dollar block then inflation obviously is an issue, and a major issue at that. Moreover, so far central banks in the global dollar block are way behind the curve as far as grappling with inflation is concerned. In those circumstances, why wouldn’t investors flee to gold?
Further reading on international gold markets and inflation and deflation:
- Fear adds lustre to gold, Blog post by Anthony Harrington
- Methods for Dealing with Inflation Risk, QFINANCE checklist
- Trust, Fear, and a Dead Economist, by Todd Buchholz
- A Not So Cheerful Future for LBOs, by Jon Moulton
Tags: banking , bubble , deflation , derivatives , gold , inflation , sovereign debt , US dollar