They should invent a new financial term for gold’s recent bust. “Flash crash” doesn’t cut it. Something like “Two bricks slamming your nuts in” would be more appropriate. See, gold’s been rising for 12 years straight. And up till April 15th, 2013, we thought the only way to secure your money further would be to weld it into a battle tank. So what went wrong? And more importantly, when will gold prices recover?
Gold’s Recent Flash Crash
On April 15 2013, gold prices fell by 9% to $1,361 per ounce. This was the biggest drop since 1983, and we haven’t seen a strong recovery (It’s back to around $1,460 per ounce, but that’s as far from pre-April 15th prices as Bin Laden is from lively).
The question is why. I spoke to investor Andrew Chiang, who’s kept 20% of his portfolio in gold since 2007:
“There are two reasons that I find plausible for the bust. The first is an announcement from US Federal Reserve Chairman Ben Bernanke, who claimed unemployment rates had fallen, and that they were considering revising their monetary policy. That could mean no more liquidity events, like quantitative easing. (Wait… whaaat? See here for an explanation on quantitative easing – Ed.)
The second was the fear that Cyprus would sell off its gold reserves to relieve its debt, thus flooding the market with a supply of gold.
Or maybe it was both events, close together, that caused the bust. In any case, some big investors began selling gold, and others jumped on the bandwagon. One cow panics and the herd stampedes.”
I also got quick comments from a financial analyst, who only wanted to be known as Alphonse:
“Gold prices have been rising for, what, 10 or more years? If you look at the chart, the price has been steadily up,up, up since early 2000. Nothing rises forever, and this is a correction* that’s long overdue.”
Alphonse also adds that China’s economic slowdown could be impacting the demand for gold.
(*A fall of 20% or more is technically bear market territory, not a correction. Alphonse also mentions this, later in the article. I left the word “correction” because that’s what was quoted.)
At this point, you’re probably playing a huge connect-the-dots game to see the relationships. Let’s simplify it:
The Connection to Quantitative Easing
Gold is a hedge against inflation. And inflation’s caused by monetary policies like quantitative easing. Here’s how they’re connected:
The more money central banks pump into the economy (quantitative easing), the higher inflation rises. This creates a demand for gold, since gold prices rise with inflation, whereas investments like stocks can’t keep up.
So long as America floods the economy with cash, inflation and gold prices will probably rise. Then comes an announcement like Ben Bernanke’s. Andrew says:
“When he (Bernanke) announced that unemployment in the US had fallen, and that they were revising their monetary policy, the alarm bells rang. Some major investment houses thought America would raise its reserves, and leave less cash in the economy.
That meant inflation might fall, and that gold was no longer as valuable. It also meant there might soon be a need for more liquidity. So some major players cashed in their gold. And because they were such big players, many panicked and followed their lead.”
Cyprus and China
Gold prices are affected by demand, and the supply of gold in the market.
Now, if Cyprus decides to sell enough gold to fix its bankruptcy problem (and Cyprus needs to raise about SGD $12 billion for a bailout), that would mean Scrooge McDuck levels of gold being released into the market.
And bear in mind, it doesn’t matter whether Cyprus actually does this. The mere threat of releasing that much gold is enough to drive down prices.
As for China, Alphonse says:
“China constitutes a major part of the demand for gold. And China’s economic slowdown means their people have less buying power, and will buy less gold.”
When Will Gold Prices Recover?
The only two agreements are (1) gold prices will recover, and (2) the recovery won’t be quick.
Andrew thinks rabid gold buying will eventually restore prices:
“It’s a technical bear, but look at the reality behind it. Whether with gold or stocks, there is usually a lot of buying following an abnormal sell-off. And once gold prices fall too far, people will rush to buy. We’re already seeing signs of recovery.
But it might take a while before we return to pre-April 15 prices. A contributing factor is the stronger performance in the stock market, which might encourage investors to look at equities instead.”
Alphonse agrees, but he isn’t buying gold right now:
“I suspect the recovery you’re seeing is just a dead cat bounce*, and gold prices can go lower. I’ll wait before buying. I’ll see what happens when Cyprus sells its gold, or if the slowdown in China worsens.”
We’ll be following what happens with gold recovery over the next few months. Follow us on Facebook, and we’ll clue you in with updates.
*Dead cat bounce = When prices fall sharply, investors often rush to buy because they believe prices have bottomed out. This can result in a brief rally, before prices continue to fall again. Derived from the saying that, when dropped from high enough, even a dead cat will bounce.
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