Like chess, only without the dice
It is hard to find an economic explanation for gold’s sharp fall
Apr 20th 2013
GOLD suffered its biggest two-day fall in 30 years on April 12th and 15th. When an asset falls so sharply in price, it is tempting to believe that significant economic changes must be afoot. But an examination of the background to bullion’s decline simply produces puzzlement.
One potential explanation is that investors have at last recovered their risk appetite and are selling gold to buy equities. But although that may have been true in the first three months of the year, it was hardly the case on April 15th, the day of gold’s biggest decline, when the S&P 500 dropped as well.
In any case, what would explain this sudden optimism? Some investors believe that America grew robustly in the first quarter but the latest data—from unemployment and retail sales to consumer confidence and the purchasing managers’ survey of manufacturing—have been disappointing. The same is true of other parts of the world, including China, where first-quarter growth was below expectations, and Germany, where the ZEW survey of economic sentiment fell sharply in April. The IMF lowered its global-growth forecast for the year on April 16th.
Commodity prices in general have been suffering, not something you would expect if investors believed that the world economy was rebounding. The price of a barrel of Brent crude oil has fallen by 10.6% so far this year. Copper, often seen as a bellwether of global activity, has dropped by 8%.
Furthermore, if economic sentiment were improving significantly, you would expect investors to sell government bonds as well as gold. But the ten-year Treasury-bond yield has fallen by more than a third of a percentage point since March 11th. The latest survey of fund managers by Bank of America Merrill Lynch shows that they have become less optimistic about growth in recent months, and have increased their holdings of cash.
Another potential explanation for gold’s fall is linked to central-bank policy. The most recent set of Federal Reserve minutes suggested that the pace of quantitative easing (QE), the creation of money to buy assets, would slow later this year. Many of the most enthusiastic buyers of gold believed that QE would ultimately lead to rapid consumer inflation. So far that has not come to pass: expectations for American inflation over the next ten years, as measured by the difference between the yields on normal and inflation-protected bonds, dropped to 2.4% on April 16th, the lowest level since November. If QE is tapering off and inflation is low, the case for buying gold is weaker.
Yet the obituaries of QE seem premature. First, the Fed has said in the past that the policy is likely to continue until the outlook for jobs improves substantially. Given the recent turn for the worse in economic data, which occurred after the Fed’s last policy meeting, that point still seems a long way off.
Second, the Bank of Japan has just unveiled a highly aggressive form of QE. With the yen declining in response, many analysts have been talking about a Japanese liquidity boost for the world. That ought to make gold bugs salivate.
In short, it is hard to find a rationale in the current economic outlook that would simultaneously send gold and bond yields down, and stockmarkets up. Perhaps investors are simply as confused as Lukas Podolski, a German football player who described the game as “like chess, only without the dice”.
The usual explanation for sharp price movements, when an economic rationale seems lacking, is that someone is selling off their holdings at any price. Some have pointed at Cyprus, which may have to sell gold in response to its debt crisis. Although Cyprus’s gold holdings are small, the fear is that other troubled eurozone nations may follow suit.
But the biggest sell-off so far is in the private sector. During gold’s long bull run (see chart above), retail and institutional investors piled into the metal via exchange-traded funds (ETFs). Some of these purchases were seemingly driven by the belief that gold was a one-way bet. Now that the price is falling, investors are fleeing. According to Morgan Stanley, ETFs have sold 249 tonnes of gold this year, compared with the 14 tonnes of reserves that Cyprus is able to sell.
Gold, having no yield or earnings, is hard to value. That was a help when the price was rising, since the sky seemed to be the limit. But now that the metal is falling, the lack of valuation support is a curse. Like the government-backed paper money that gold bugs despise, gold is precious only so long as enough people agree that it is.