If you’ve been paying attention, you’ll remember how gold can make financial crises fun. Gold bulls were so short of things to keep them awake at night that many will be grateful for the 20% plunge of late 2011.
“We think the peak would be toward the end of this year or maybe sometime in the first half of next year,” says Neil Meader, research director at precious-metals consultancy GFMS, which Thomson-Reuters acquired in 2011.
The trigger for gold’s final top and decline? “Anything that really signals to the market that the structural imbalances and the problems affecting the strength of various currencies are moving behind us — that we are moving beyond this current financial-crisis situation,” says Meader, speaking to TheStreet after launching GFMS’ latest Gold Survey Update in New York on Tuesday.
Now, whatever you make of that risk, gold investors should perhaps be pleased to see the world’s leading data and analysis provider flagging such an event. Like pullbacks in a bull market, it can only be healthy to consider the inevitable end.
In particular, says Meader, “one overt trigger that is worth looking for is the start of a serious ratcheting up of interest rates. Because for gold investment to be popular, you do need really low interest rates.”
Of course, the risk of higher interest rates looks about as high right now as interest rates themselves — i.e., zero. Even where the cost of borrowing or the return on cash is better than nothing, it isn’t after you account for inflation. And as BullionVault never tires of reminding people, it’s that rate — the real rate of interest — that really matters to the ebb and flow of gold demand.
|Avg annual yield on 10-year
T-bonds after inflation
|Real change in dollar
gold price after inflation
|2000 to date||1.66%||303%|
Hence, the rise in global gold prices, rather than just in dollars, over the last decade. That’s clear in our Global Gold Index, mapped above. The GGI prices gold against a weighted basket of the world’s top 10 currencies, as measured by the size of their issuing economy. That has risen fivefold over the last decade, just as the S&P index of the 500 largest U.S. corporations did in the 1990s. Unlike the S&P, however, gold hadn’t already risen fivefold in the previous 15 years.
Still, this run can’t continue indefinitely. And pending the big downturn in gold prices expected for year-end 2012 or early 2013 or whenever this financial crisis is finished and things get back to what we used to call normal, here’s three things that are likely to make gold owners reach for a sedative at some point or other:
Oh, sure — gold offers unique insurance against default or devaluation because it can’t be created or destroyed, and it is no one else’s liability to renege on (so long as you own it outright). Short term, however, a credit squeeze is likely to force up the dollar and drain liquidity from derivative markets, including gold futures. Repeating the impact of Lehman’s 2008 collapse, Europe’s credit crunch in the second half of 2011 forced the collapse of broker MF Global, further helping the speculative position in U.S. gold futures fall in half. That’s certain to dent prices short term, even if investment demand for physical bar and coin is surging for fear of the political and monetary reaction.
The Middle Kingdom is supposed to be an unalloyed boon for gold prices. Disappointing both GFMS and ourselves by failing to take over India’s top spot in 2009, China is likely to move closer in 2012. But unlike demand in the developed West, Chinese gold demand clearly shows a significant and positive link with economic growth — and no one yet knows how a credit squeeze, or “hard landing,” might affect the globe’s fastest-growing market for physical bullion. Our guess is that tight credit and stalling income growth wouldn’t be good for gold. Beijing’s response might be, though, if 2008-2009 is any guide.
In 2011, volatility in gold prices still lagged behind U.S. equities, but that’s little comfort if you imagined that owning gold would let you sleep through the night. Owning physical property, in law, means you escape credit, not price risk. Scarier still for retained wealth trying to hide from the storm in gold, volatility is known to dent India’s household buying, the world’s largest single source of demand. Imports fell 8% by weight in 2011, thanks to a near-collapse in the final three months. There’s also a risk that, after rising each year since 2001, the recent whipsawing of gold’s price might dissuade Western investors, too. After all, if gold is supposed to be a “safe haven,” it failed in the second half of 2011, even though it has tripled during this five-year crisis so far.
There you go: That’s enough noise to keep you awake tonight. For tomorrow, there are plenty of other nightmares threatening your wealth elsewhere. Surging real interest rates paid to your cash savings shouldn’t be one of them.
Adrian Ash is head of research at BullionVault.