Gold’s Swoon – It wasn’t supposed to be like this…
While we don’t often wander off into macro-economic factors very often, it is impossible not to interpret the current fall in the gold (and silver) price except in this context.
The main drivers for gold traditionally have been:
- Political risk
- Monetary debasement
- Inflation risk (usually a result of monetary degradation)
Much of the last decade has seen the gold enthusiasts latch onto monetary degradation as their main driving force for gold at anywhere between $2,000 and $10,000. The concept of Quantative Easing (QE) was not the word on every goldbug’s tongue at the turn of the century because even Central Bankers weren’t using it in recent years. QE has replaced “the printing press” as the Great Satan for those who feel that monetary expansion is the great enemy of fiat currency and thus a fire under the gold price.
The problem that the gold advocates have suffered is that the corollary of debasement is inflation and it just hasn’t happened. Or maybe we should rephrase that. Prices as measured by doctored CPI and PPI numbers have not reflected the inflation and instead we have had falling interest rates and the inflation has been channeled into house prices and other select asset classes. If anything the concern of governments has turned to the brutal deflationary tendency which has gone from being endemic in Japan post-1980s to a spreading virus that is now embedded in Europe and most patently manifested in negative interest rates which reign in places like Switzerland and Denmark and are being threatened in other places.
Low to negative rates have made holding precious metal assets a cheap option on resurgent inflation.
The Worm has Turned?
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Recent weeks have seen the gold price flattened like a bulldozer has ridden over it. Ironically as the Fed’s bankers in the US start to look for incipient inflation (surely good for gold) it is the fear of higher rates and their effect on the carrying cost for gold that has clocked the gold price on the head. The real fall though was paralleled by the decline in the pound. This was NOT gold reacting due to Brexit fears but rather I believe the result of the idea sinking in that the UK will also raise rates. This would be to try an head off inflation caused by the steeply lower pound raising the cost of imports. The fall in the pound needs to be put in perspective that it is only of the same order as the corrective moves that were seen in the AUD and CAD between 2013 and 2015 which restored those countries to competitivity and did not involve interest rate rises.
If the US raises and the UK raises we will be seeing the first interest rate hikes since the middle of last decade. Just as the Fed started hiking then the global financial crisis hit and the rising trend proved to be very short-lived.
This time around the tendency could be prolonged. It could indeed be the end to the Great Deflation that has reigned really since the start of this century. It has temporarily proved to be negative for gold, but longer term it could prove a dampener on what has become an unsustainably over-priced housing market around much of the world. Inflation in no-property goods could ultimately be, again, a motor for higher gold prices.
A New Paradigm?
So the latest fear is that holding costs for gold will go up with higher interest rates and thus that investors will not want to hold gold. This produced the tumble of recent weeks.
This is more of a changing of the rationale than necessarily a permanent step lower. Thus debasement of the money base retreats as a fear and it is the inflation factor that starts to kick in. How long it will take for inflation to kick in as a real fear remains to be seen.
With official inflation numbers having been only a few percentage points for decades now it is hard to generate a fear of inflation in the minds of the public. In the 1970s and early 1980s it was a real and present danger and this has scarred a generation of central bankers who fought it like it was the Great Satan. Now deflation has taken that role as it has created immense distortions in capital allocations (e.g. too much capital being embedded in house prices) and a disaster on the pensions front as savings gain virtually no return and pension fund contributions fail to compound as previously believed with a surge in the life expectancy of the bulk of retirees. Frankly inflation should be welcomed back and real returns for savers are required.
Gold may be collateral damage, temporarily, of this paradigm shift but ultimately if we are back on track to the “normality” of inflation then gold’s fans will at least be able to return to the familiar territory of a danger they have traditionally understood rather than the obscure will-o-the-wisp of QE, which has singularly failed to generate sustained uplift in the gold price.
Maybe the rate rises will work and damp inflation…maybe not.. maybe the rises will spread to other jurisdictions. We might remind gold fans of the old Chinese curse: May you live in interesting times.
Christopher Ecclestone is a Principal and mining strategist at Hallgarten & Company in London. Prior to founding Hallgarten & Company in New York in 2003 ... <Read more about Christopher Ecclestone>