Sharp Decline in Gold Prices Means Different Things in Context; Most of Them Positive
Accurately predicting the short-term direction of gold prices is difficult. So many different economic factors are at play, not to mention major macro data shifts and insolvencies no one sees coming. Sprinkle in the admitted manipulation in precious metals prices by big financial institutions, and it’s enough to make a chartist change careers. Perhaps that’s why long-term holders of physical gold care less about the paper price, and more about how much they can acquire when it sells on discount.
Although predicting gold prices per ounce based on charting is hard, other evidence is available. Those hard sell-off days can provide interesting clues about the future direction of gold prices. Often times, the post-news reaction in prices gives us a clearer picture than any chart could.
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That’s where knowing the gold price history is important. Gold isn’t a simple commodity like all others. It isn’t dependent on a strong economy or industrial demand for its strength or weakness. Mineable supply is limited to a maximum of two percent per year, because it’s impossible to “print” more of it in order to facilitate more credit. Bankers and governments hate it for that reason. Gold is kryptonite to debt spending and credit issuance, to which America is addicted.
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Therefore, it shouldn’t surprise anyone that many experts believe gold prices are being artificially fixed. Much evidence has been uncovered over the years, including a New York University’s Stern School of Business study conducted by Professor Rosa Abrantes-Metz and Albert Metz, a managing director at Moody’s Investors Service, which concluded, “The structure of the benchmark is certainly conducive to collusion and manipulation, and the empirical data are consistent with price artificiality.” (Source: “Gold Fix Study Shows Signs of Decade of Bank Manipulation,” Bloomberg, February 28, 2014.)
The intent isn’t to prove or disprove the extent of gold price manipulation. We’ll leave that for our audience to judge. But on days when gold is “maneuvered” lower by two or three percent on no news, we believe the intent is to demoralize investors and discourage buying. Why else would billions of dollars’ worth of gold contracts get dumped in the futures market without any regard for best price from time to time? Again, we leave it for our readers to decide.
Regardless, while no-news hammer selling is a fact of life, rarely is this type of selling ongoing or systematic. There’s no fundamental reason behind it that should scare off investors. It just serves to cap prices for the next weeks or months. This is frustrating for those who care about short-/intermediate-term capital appreciation. However, investors with a longer-term horizon (think years or family heirloom) may appreciate adding more gold at discount.
That’s much easier to do when you’re convinced prices are being “capped” as opposed to buying at cyclically unfavorable times.
Liquidation Based on Hard Economic Data
When gold liquidates hard based on unfavorable hard economic data, this has greater importance. It can mean that several large market participants decide to throw in the towel based on fundamental reasons. These types of falls generally have more legs to them.
So what can cause such a fall? Generally, this would pertain to better-than-expected data related to the strength of the U.S. economy. Why? Because gold’s role is diminished in times of sound economic growth. There are several reasons why this is true.
For one, the likelihood of additional debt monetization and stimulus spending is reduced. When there are more dollars in circulation (or the threat of such), investors tend to hold gold as fiat dollars get diluted. Strong economic conditions also foster strong-performing stock markets, which provide better capital returns and stronger dividend yields than gold (which doesn’t have a yield). Additionally, there are fewer safe-haven demands for gold, since there are few market impairments to worry about.
Some economists hypothesize that if the U.S. economy continuously experienced stable growth, zero or low government deficits, and public/private credit creation, growth rates in-line with economic potential, then the intrinsic value of gold prices today might well be $600.00 or $700.00 an ounce. In other words, there would be little reason to own it at all.
Again, we’ll leave it to our readers to decide, but the previous point is moot. The exact opposite of the conditions described in the last paragraph are at play today. Government spending is out of control; public/private loan growth due to rock-bottom interest rates is much too high; crushing deficits are impairing sound economic growth, and promise even more debt spending will be needed ahead. In short, investors have never had more reason to own gold as a hedge against further monetary debasement and financial shocks.
For long-term investors looking to add to positions, the reason for declining gold prices matter. If the price is being monkey-hammered for no economically sound reason, worry less. If economic data is really pointing to stronger growth ahead, or a new business cycle is just beginning, you may want to consider holding off additional purchases.
Our gold price forecast reflects the fact that on-balance, economic growth is more likely to stall out, possibly leading to a new round of monetary gimmickery and low interest rates when it does.
