Vivek Kaul
At the very outset let me confess that this has been a difficult piece to write. When everyone around you is shouting the same thing from their rooftops, it is very difficult to say something which happens to be exactly the opposite.
Gold over the last one week has turned into a four letter word. Last Thursday (i.e. April 11, 2013) the closing price of the yellow metal was $1564.2 per ounce (one troy ounce equals 31.1 grams). A week later as I write this gold is selling at around $1375 per ounce. The price has fallen by around 12.1% over the period of just one week.
And this fall has suddenly turned investment experts (at least the ones who appear on television and write and get quoted in newspapers) all bearish on gold. They have been giving different reasons to stay away from it. But if they were so confident that the price of gold would fall, as it has, why didn’t they warn the investors before fall? Everything is obvious after it has happened.
But as the Nobel Prize winning economist Daniel Kahneman writes in Thinking, Fast and Slow “The ultimate test of an explanation is whether it would have made the event predictable in advance”. Those offering the explanations now, clearly did not predict the massive and sudden fall in price of gold. What is interesting is that before the price of gold started to fall the Bloomberg consensus forecast for gold by the end of 2013 was at $1752 per ounce. Hence, the broader market did not see this coming.
So why is the price of gold falling? One conspiracy theory doing the rounds has the investment bank Goldman Sachs at the heart of it. As John Cassidy of the New Yorker magazine puts it “Last December, Goldman’s economic team turned bearishon gold, saying the multi-year upward trend in gold prices “will likely turn in 2013.” And last Wednesday,(i.e. April 10, 2013) the bank’s commodities team advised its clients to start shorting gold.” Short selling refers to a scenario where investors borrow gold and sell it with the hope that as the price falls they can buy it back at a lower price and thus make a profit.
Goldman Sachs was not the only big bank turning negative on gold. On April 2, the French bank, Societe Generale, the also issued a report titled The end of the gold era, and turned bearish on the yellow metal.
This many believe is a conspiracy on part of the big banks to drive down the price of gold. As Paul Craigs, a former assistant US Treasury Secretary told Kings World News “This is an orchestration. It’s been going on now from the beginning of April…Brokerage houses told their individual clients the word was out that hedge funds and institutional investors were going to be dumping gold and that they should get out in advance. Then, a couple of days ago, Goldman Sachs announced there would be further departures from gold. So what they are trying to do is scare the individual investor out of bullion. Clearly there is something desperate going on.”
Nevertheless, conspiracy theories are easy to talk about but difficult to prove. There are several other reasons being offered on why the price of gold will continue to fall. A major reason being offered is the improvement in the American economic scenario and that leading to the Federal Reserve of the United States, the American central bank, printing lesser money in the days to come.
The Federal Reserve currently prints $85 billion every month in the hope of reviving the American economy. Societe Generale in its report The end of the gold era believes that this will continue till September and come down to $65 billion after that, until being fully terminated by the end of the year.
The Federal Reserve on its part has guided that money printing will come down if it sees a ‘significant improvement in the outlook for employment’. The latest U3 rate of unemployment in the United States for the month of February 2013 stood at 7.6%. U6, a broader measure of unemployment, was at 13.8%. Both numbers have declined from their peaks. U6 touched a high of 17.2% in October 2009, when U3, which is the official unemployment rate, was at 10%. In December 2012 U6 stood at 14.4% and U3 was down to 7.8%.
So yes things have improved but they are still far away from being fine. U3 in the pre-financial crisis days used to be at around 5%. Also long term unemployment (where people are out of work for 27 weeks or more) has changed little and is at at 4.6 million or 39.6% of the unemployed people(U3).
(There are various ways in which the bureau of labour standards in the United States measures unemployment. This ranges from U1 to U6. The official rate of unemployment is the U3, which is the proportion of the civilian labour force that is unemployed but actively seeking employment. U6 is the most broad definition of unemployment and includes workers who want to work full time but are working part time because there are no full time jobs available. It also includes “discouraged workers”, or people who have stopped looking for work because the economic conditions the way they are, make them believe that no work is available for them.)
Another measure of the US economy turning around is the increase in real estate prices. As per the S&P Case-Shiller 20 City Home Price Index, real estate prices have gone up by 8.1% between January 1, 2012 and January 1, 2013. This after falling by 3.9% between 2011 and 2012.
One of the reasons the Federal Reserves prints money is to ensure that there is enough money going around in the financial system and interest rates continue to remain low. This ensures that people borrow and spend more. Hence, the low interest rates have helped in reviving the real estate sector in the United States.
But lets think for a moment on what will happen if the Federal Reserves stops printing money? Interest rates are likely to go up. People will take on fewer home loans to buy homes and that in turn will mean the real estate sector will go back to the dumps that it was in. So will the Federal Reserve take the risk of going slow or stopping money printing? Also, economic growth for the three months ending December 2012, was at -0.1%. So much for the American economy improving.
In this scenario it is unlikely the Federal Reserve will go stop money printing anytime soon, even though its Chairman Ben Bernanke, its Chairman, may keep dropping hints about doing the same.
As Stephen Leeb writes on www.Forbes.com “The Federal Reserve also wants to beat up on gold, via its drumbeat, suggesting that liquidity may be drying up and monetary easing might end soon. Never mind that recent economic data, on the whole, appears much weaker than expected, or that any halt to U.S. monetary easing could only follow higher inflation and commodity prices.
And as long as United States keeps printing money gold will remain a good investment bet, its current huge fall notwithstanding.
The last bull market in gold ended soon after the legendary Paul Volcker took over as the Chairman of the Federal Reserve in August 1979. As economist Bill Bonner wrote in a recent column “Paul Volcker replaced G. William Miller as chairman in August 1979. A loose money policy became a tight money policy. Volcker jacked up interest rates…But what’s the Fed doing now? Has it reversed course? Has Ben “Bubbles” Bernanke been replaced with a tough-as-nails inflation fighter? Has the Federal Open Market Committee(FOMC) vowed to stop printing money? Has the loosest monetary policy in US history given way to a tight policy?”
And the answer on all the above counts is a big no.
Moving on, another reason given for the gold price falling is that Cyprus is selling gold worth $500 million in order to raise cash to pay its debt. As Peter Schiff president of Euro Pacific Capitalwrote in a recent column “Concerns quickly spread that other heavily indebted Mediterranean countries with large gold reserves like Greece, Portugal, Italy and Spain would follow suit. The tidal wave of selling would be expected to be the coup de grace for gold’s glory years.”
The stronger countries of the euro zone (the countries which use euro as their currency) led by Germany have been rescuing the heavily indebted weaker ones for a while now through multi billion dollar rescue packages. In case of Cyprus the rescue came with terms and conditions which included seizing a part of its banking deposits and selling its gold.
This experts feel is likely to be repeated in the days to come with other countries as well. What they forget is that if the euro zone makes a habit of seizing deposits and selling gold, countries are likely to opt out of the euro and move onto their own currencies. As James Montier writes in a recent research paper titled Hyperinflations, Hysteria, and False Memories “If one were to worry about hyperinflation anywhere, I believe it would have to be with respect to the break-up of the eurozone.” Another reason to keep holding onto gold. If there is even a slight whiff of a euro breakup gold is going to fly.
Another logic being bandied around (especially by some of the Indian analysts) is that with the price of gold falling the investment demand for gold is likely to go down. Fair point. But a falling gold price can also push up the jewellery demand for gold. In 2011, gold jewellery consumed around 1972.1 tonnes of gold. This was down to 1908.1 tonnes in 2012, as prices rose.
A slowdown of Chinese growth has been offered as another reason for gold prices falling. As Cassidy of New Yorker writes “Many of today’s news storiesabout the gold price emphasized disappointing economic figures from China, which showed economic growth slowing down slightly in the first three months of 2013. China is a big consumer of virtually all natural resources, and gold was but one of many commodities that fell sharply after the report from Beijing.”
But this theory doesn’t really hold either. “The purported slowdown in the Chinese economy was very slight. First quarter growth came in at 7.7 per cent, compared to 7.9 per cent in the last three months of 2012. Allowing for the vagaries of the statistics, the difference is inconsequential,” writes Cassidy.
Also the gold bears who have suddenly all come out of the closet are not talking about what is happening in Japan. Japan has decided to double its money supply by printing yen to create some inflation. The hope is hat all this new money will create some inflation as it chases the same amount of goods and services, leading to a rise in prices. When people see prices rising, or expect prices to rise, they are more likely to buy goods and services, than keep their money in the bank. This is the logic. And when this happens businesses will do well and so will the overall economy.
A side effect of this money printing which is expected to be thrice as large as that in the United States, is the Japanese yen losing value against other major currencies because a surfeit of yen is expected to flood the financial system.
A weak yen also makes Japanese exports more competitive. (For a detailed argument click here). But it puts countries like Taiwan, South Korea, China and even Germany in a spot of bother. As Societe Generale analysts write in a report titled How to make profits from the Sushi-style QE in Japan “In effect Korea, Taiwan and China are losing competitiveness while Japan regains it.”
Printing money is not rocket science, if Japan can print money, so can the other countries in order to weaken their currency and thus keep their exports competitive. Hence there are chances of a full fledged global currency war erupting. And this is another reason to own gold.
The final argument against gold has been that central banks have been printing money for more than four years now. But all that money has not led to high inflation, as the gold bulls had been predicting that it would. So central banks have managed to slay the inflation phantom. “After more than four years of quantitative easing in the United States, the inflation rate, as measured by the consumer price index, is running at just two per cent…In Britain, where the Bank of England has followed policies similar to the Fed’s, the inflation rate is 2.8 per cent—a bit higher, but hardly alarming,” writes Cassidy.
But just because money printing hasn’t led to inflation till now doesn’t mean we can rule out that possibility totally. There is huge historical evidence to the contrary. Let me quote Nassim Nicholas Taleb here, something that I have done in the recent past. As Taleb writes in Anti Fragile “Central banks can print money; they print print and print with no effect (and claim the “safety” of such a measure), then, “unexpectedly,” the printing causes a jump in inflation.” James Rickards author Currency Wars: The Making of the Next Global Crises says the same thing “They can’t just keep printing…All major central banks are easing…Eventually so much money will be printed that this will lead to inflation.”
And in a situation like this, gold will be the last man standing.
To conclude, this is how I feel about gold. I maybe right. I maybe wrong. That only time will tell. Hence its important to remember here what John Kenneth Galbraith, an economist who talked sense on most occasions, once said: “The only function of economic forecasting is to make astrology look respectable.”
Given this it is important that one does not bet one’s life on gold going up. An allocation of not more than 10% in case of a conservative investor is the best bet to make. And if you are already there, stay there.
The article originally appeared on www.firstpost.com on April 18, 2013.
(Vivek Kaul is a writer. He tweets @kaul_vivek)