Monday, November 24, 2014

After the Gold Rush

VENICE – The run-up in gold prices in recent years – from $800 per ounce in early 2009 to above $1,900 in the fall of 2011 – had all the features of a bubble. And now, like all asset-price surges that are divorced from the fundamentals of supply and demand, the gold bubble is deflating.

At the peak, gold bugs – a combination of paranoid investors and others with a fear-based political agenda – were happily predicting gold prices going to $2,000, $3,000, and even to $5,000 in a matter of years. But prices have moved mostly downward since then. In April, gold was selling for close to $1,300 per ounce – and the price is still hovering below $1400, an almost 30% drop from the 2011 high.

There are many reasons why the bubble has burst, and why gold prices are likely to move much lower, toward $1,000 by 2015.

First, gold prices tend to spike when there are serious economic, financial, and geopolitical risks in the global economy. During the global financial crisis, even the safety of bank deposits and government bonds was in doubt for some investors. If you worry about financial Armageddon, it is indeed metaphorically the time to stock your bunker with guns, ammunition, canned food, and gold bars.

But, even in that dire scenario, gold might be a poor investment. Indeed, at the peak of the global financial crisis in 2008 and 2009, gold prices fell sharply a few times. In an extreme credit crunch, leveraged purchases of gold cause forced sales, because any price correction triggers margin calls. As a result, gold can be very volatile – upward and downward – at the peak of a crisis.

Second, gold performs best when there is a risk of high inflation, as its popularity as a store of value increases. But, despite very aggressive monetary policy by many central banks – successive rounds of “quantitative easing” have doubled, or even tripled, the money supply in most advanced economies – global inflation is actually low and falling further.

The reason is simple: while base money is soaring, the velocity of money has collapsed, with banks hoarding the liquidity in the form of excess reserves. Ongoing private and public debt deleveraging has kept global demand growth below that of supply.

Thus, firms have little pricing power, owing to excess capacity, while workers’ bargaining power is low, owing to high unemployment. Moreover, trade unions continue to weaken, while globalization has led to cheap production of labor-intensive goods in China and other emerging markets, depressing the wages and job prospects of unskilled workers in advanced economies.

With little wage inflation, high goods inflation is unlikely. If anything, inflation is now falling further globally as commodity prices adjust downward in response to weak global growth. And gold is following the fall in actual and expected inflation.

Third, unlike other assets, gold does not provide any income. Whereas equities have dividends, bonds have coupons, and homes provide rents, gold is solely a play on capital appreciation. Now that the global economy is recovering, other assets – equities or even revived real estate – thus provide higher returns. Indeed, US and global equities have vastly outperformed gold since the sharp rise in gold prices in early 2009.

Fourth, gold prices rose sharply when real (inflation-adjusted) interest rates became increasingly negative after successive rounds of quantitative easing. The time to buy gold is when the real returns on cash and bonds are negative and falling. But the more positive outlook about the US and the global economy implies that over time the Federal Reserve and other central banks will exit from quantitative easing and zero policy rates, which means that real rates will rise, rather than fall.

Fifth, some argued that highly indebted sovereigns would push investors into gold as government bonds became more risky. But the opposite is happening now. Many of these highly indebted governments have large stocks of gold, which they may decide to dump to reduce their debts. Indeed, a report that Cyprus might sell a small fraction – some €400 million ($520 million) – of its gold reserves triggered a 13% fall in gold prices in April. Countries like Italy, which has massive gold reserves (above $130 billion), could be similarly tempted, driving down prices further.

Sixth, some extreme political conservatives, especially in the United States, hyped gold in ways that ended up being counterproductive. For this far-right fringe, gold is the only hedge against the risk posed by the government’s conspiracy to expropriate private wealth. These fanatics also believe that a return to the gold standard is inevitable as hyperinflation ensues from central banks’ “debasement” of paper money. But, given the absence of any conspiracy, falling inflation, and the inability to use gold as a currency, such arguments cannot be sustained.

A currency serves three functions, providing a means of payment, a unit of account, and a store of value. Gold may be a store of value for wealth, but it is not a means of payment; you cannot pay for your groceries with it. Nor is it a unit of account; prices of goods and services, and of financial assets, are not denominated in gold terms.

So gold remains John Maynard Keynes’s “barbarous relic,” with no intrinsic value and used mainly as a hedge against mostly irrational fear and panic. Yes, all investors should have a very modest share of gold in their portfolios as a hedge against extreme tail risks. But other real assets can provide a similar hedge, and those tail risks – while not eliminated – are certainly lower today than at the peak of the global financial crisis.

While gold prices may temporarily move higher in the next few years, they will be very volatile and will trend lower over time as the global economy mends itself. The gold rush is over.

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    1. CommentedParrain Boursorama

      The best model for expanding Alternative Energies and Environmental Protection globally is through using market equilibrium, whereas governmental subsidies and fiscal stimulus to be just supplementary

    2. CommentedLuis de Agustin

      Dr. Roubini here makes excellent points to support his thesis. His forecast may very well be right; history will tell. It’s a classic situation like that of the blind men touching the elephant before them, each one drawing conclusions based on where they stand.

      If we take the perspective of a different seer, R. David Ranson, chief economist of Wainwright Economics, the basis for the current price of gold and the outlook become different, and the plunge in the price of gold is a good thing done for the wrong reason. The cause of the plunge says Ranson, cannot be expectations of improvement in the US government debt situation. Still, any fall in the gold price should always be cause for economic optimism. Coupled with tightening spreads, and as long as it lasts, it’s bullish for the US stock market, and good for US economic growth, although the effect might be slow to show up. At the same time it’s bearish for commodities, foreign currencies, foreign stock markets, and many other assets.

      On the less optimistic side, the inability of authorities to control the price system means that gold will creep back in a volatile way toward its pre-plunge price. It’s very difficult for a highly indebted government to keep its currency from depreciating, and repeated interventions mean currency instability. That per se is bad for resource allocation and the economy. But that is so “tomorrow that may never come.” From stock buyers there is nothing but a great big bear hug and kisses for Mr. Bernanke, even a chariot ride around downtown Manhattan would be befitting.

      How long gold stays down depends on how long the forces that depressed it continue. The panic has abated. The rest of the answer is a political judgment for the Fed. One salient factor is the speed at which US growth proceeds. If that disappoints as Dr. Ranson expects, the Fed will be more intent on keeping interest rates down. And since a rising price for gold is an impediment to that policy, it implies more Fed action to keep gold down as well. The adoring crowds cheer of as the giver of mullah showers us with cascades of cash. It’s only natural.

      In the meantime, an underwhelmed Wainwright Economics expects further climbing back for gold, although the price of gold will stay below where it was a year ago. Logic dictates two market responses, says the sober 30-year old advisory. One is norm reversion (price movements in silver, other precious metals and commodities in general tend to parallel gold, with a delay, so that their prices in terms of gold converge to pre-existing ratios). The other response is the swing in favor of “soft” assets such as US equities and bonds.

      The implications for tactical investment strategy are to re-tilt portfolios toward assets correlated positively with stocks and bonds, and away from assets correlated positively with gold and commodities. Of course, advises Wainwright, there’s no convincing reason to alter long-term strategies that still favor hard relative to soft assets.

      Even as Chairman Bernanke continues digging a hole from which to extract soil to shore up walls around it, the tide of its breaching continues also mercilessly rising around that embankment. The maddening cheer of crowds above that silent rising - how befittingly mortal to become charmed.

      Luis de Agustin

    3. Commenteddonna jorgo

      well gold and bond's doesn't save the economy ..
      acinita ..can not help because the inflation is up anyway ..

      but i read or listening for up down market gold .?this is fun eh ..because one who doesn't understand gold to day is 800 $ and tomorrow is 1200$
      schruble game ..
      thank you i follow your writing allways

    4. CommentedD. V. Gendre

      With great respect for Mr. Roubini's work, but this article is cherry picking. The view on a single 'commodity' like gold is like the view on a single stock. And how many stocks or indexes performed better than gold during the period of 2008 to 2009? One could easily point out the same volatility and risk on thousands of stocks (AIG, Citi, GM, AAPL etc.). What about a possible bubble in stocks and indexes right now? Unfortunately most economists like to cherry pick just to proof something that is not to proof and even not comparable. The case of gold is like any other case for investors. Besides knowing the fundamentals the most crucial thing is the timing.

    5. CommentedBrian Wills

      Some of Robini's arguments are valid if you are focused on the very near term. However, on the whole his thesis is quite flawed.

      Volitility alone is not going to drive the price of gold down over the longer term. Physical supply and demand fundamentals will be the drivers of the price. His own recommendation that investors have a modest position in gold would alone drive the price of gold to much higher levels then he could imagine.

      Gold does perform best in inflationary environments. He's right that this has not manifested itself --YET. However, the 10 Trillion dollars plus in QE that presently[ much of which] is being hoarded will eventually make it's way into the world economy. When you take into account the world banking system's fractional reserve practices the potential currency deluge could total 100 Trillion dollars.

      Mr. Roubini is correct that a positive real interest rate environment is not a supportive one for gold. His belief that the world's central banks will exit from QE successfully--meaning without causing a recession or rising inflation is naive at best. The political pressure will be enormous, forcing the banks to err on the side of growth and therefore inflation.

      Cyprus selling some of it's gold reserves in and of itself is completely insignificant and that was not the main reason for the recent gold sell off. Of couse, if a highly indebited country [with significant gold reserves] chose to do so it would have a negative market impact. However this is an incredibily low probability event. It is much more likely that such a country would opt for gold backed loans instead.

      Mr. Robini the gold rush is not over. The market is just experiencing a correction before it moves to new highs.

    6. CommentedMichael Lombardi

      Yes, indeed, there is a lot of pessimism surrounding gold bullion and it is mounting by the day. Speculators are of the opinion that the price of gold bullion is dropping, but central banks of nations like Turkey, Kazakhstan, Russia, etc. are increasing their supply of gold bullion and appending their reserves, as they have done in the month of April. As per the International Monetary Fund; the figures are as follows:

      Central bank of Turkey-The month of April; saw an addition of 586,000 ounces of gold bullion
      Central Bank of Kazakhstan- It added 85,000 ounces of gold bullion in its reserves in April 2013.
      Central Bank of Russia- In April, there was an addition of 269,000 troy ounces of gold bullion in its reserves.
      Also, since seven years, the first quarter of each year has been witness to the purchase of above 100 tonnes of gold bullion by central banks, as per World Gold Council, May 16, 2013. This surely paints a contrary picture of the scenario, especially with the negativity associated with the gold bullion speculators.

      As central banks continue with their gold bullion stocking actions, could we see the prices of gold bullion beginning to climb a little higher? Also, it does make us sit up and look when the normally conservative central banks indulge in this gold bullion stocking act. Does it indicate that fiat currency in which reserves of the nations are held no longer promises them the trust it once possessed?

    7. Commentedsrinivasan gopalan

      Roubini's optimism on the future course of the yellow metal that it cannot sustain its long-lasting appeal is not borne out of any reality-check. At a time when people's faith in savings instrument--be it equity or other money-backed deposits-- has dimmed pronouncedly particularly in the wake of relentless inflation in emering economies like India, gold alone offers a haven to hedge against the risks of uncertain times! How else could one explain Indians' insatiable dalliance with the yellow metal so much so that the government is now at its wit's end in stemming the soaring import cost on account of huge gold imports? No doubt, the faith in gold is a manifest irrational exuberance but in a system which allows no other kind of comfort when the chips are down, it is gold, the relic of the barbaric era, that alone appears to give comforts and cushion to hapless savers, if that class exists here! There is also a paradox that in a country like India where millions do not have two square meals, the possession of a milligram of gold by the above-poverty level people and more quantity of gold- soaked ornaments by people with means make a mockery of public policy. Either the people's faith in the extant savings instruments are too shaky or for reasons best known to them, the people are overly happy in holding on to an asset that does not given any return when it is on hold but could be a hedge against adversity when it could be sold! In any case, the government had not done its bit so far in disabusing the people of their false allegiance to a metal that has meretricious benefits only and not real good to anyone. G.Srinivasan, Journalist, New Delhi, Inde

    8. CommentedDave Lewis

      Having started my career in finance on the trading side and belatedly learning economics, I am familiar with problems caused by differing time scales between these perspectives.

      I suspect Mr. Roubini's (and this happens to many economists who start preaching to traders) perspective is shortening. From a short term perspective, Gold doesn't seem a great buy.

      However, from a long term investment perspective, (perhaps I should write "anti-investment" perspective- buying Gold takes capital out of the game) long Gold still makes sense to me. Bretton Woods II is still hanging on by a thread and much of Mr. Roubini's earlier long term analysis thereof still seems accurate.

      The game is not yet finished or so I believe. We'll see what happens in the coming months.

    9. CommentedMaher Danson

      Fortunately, no one pays attention or listens to Roubini!

      Roubini suffers from teh Leftist Hate America syndrome and has an Islamist background.

      He is clearly anti-gold no matter what the time frame is , here's what he said now:
      "Gold was juiced by right-wing fanatics in the US. That boom is over."

      If Peter Schiff is the gold nut job, Roubini is the enemies of America Hate America no matter what nut job.

    10. CommentedG. A. Pakela

      What if the market all of a sudden decided that gold was not a store of value at all and starts a sell off that doesn't end until gold is only worth its value for producing jewelry and art? Such an event, as unlikely as it might seem based on past history, would be like an infinite sigma event.

    11. CommentedKevin Vass

      In your second point, you claim weak global growth; however, in point three and your conclusion you say the global economy is recovering. This is inconsistent. Also, I watched you on Fox Business say we are forming a credit bubble and that it will be a disaster in a few years. This contradicts your underlying point in this article that the future fear will be low.

    12. Commentedted c

      Divide $2.328 trillion in promises by 111 million oz of gold in Ft Knox

      To pay our US debts requires gold >>$2,000,000/oz

      Another egghead who ignores the facts.

    13. CommentedAvraam Dectis

      Somewhere in the asteroid belt, there is a huge solid gold asteroid.

      When it is found, gold will be equal in value to copper.

        Commentedha nguyen

        to come to asteroid, we have to have energy-fuel, material, natural resource serve for launching, digging, transporting this mean it cost money to get it.So gold from must have price. it's not cheap compare to what we do in the earth, just digging & then filter the dust to get purity

    14. CommentedVictoria Mendez

      Ah yes the Gold rush is over, the Banksters have run out of real, physical gold, but they still can play the naked short paper gold racket!
      The gold rush is over for western Governments, Banksters and ETFs, since they underhandedly sold all their gold to suppress prices, a crime perpetrated for the last four decades, since the London Gold Pool collapsed in 1968! ETFs are being shorted by the Banksters and the gold is being looted to meet physical demand!
      Banksters have criminally rehypothecated 200x over the same oz of gold in customers’ pooled accounts and looted (stolen) every allocated gold account of their customers, just to meet the demand for real money!
      In fact, demand for Real Money is so overwhelming that it lead to such a crisis in the bullion banksters’ fractional bullion racket, where they were close to default because of their criminal, fraudulent racket, that a white house meeting of the top 14 banksters was called.
      And the following day on April 12th yet another massive smash started with 400 tons of (naked shorts) gold being dumped to destroy the price; in all over a thousand tons of naked papers shorts, over a year’s production, was dumped over Friday/Monday to get a destruction of $220 in the price of gold.
      But of course Banksters, the Government, Fed and BIS are all at the suppression game 24/7 and have been so since 1968 with naked paper shorts.
      ABN Amro was the first to admit that they are cleaned out of gold and will not honour their commitment and contractual obligations to its customers!

      Successful and prosperous countries all purchase gold by the truckloads, and the ailing, terminally ill countries of the west are idiotically selling their family jewels at artificially suppressed and destroyed prices to the new economic powers of the east.
      No more cogent proof of the failed and scurrilous policies of western decision makers than the shift of power to the east with the sale of gold, which is, has and always will be the real choice of money for humanity, bar the Keynesian dunces now calling the shots.
      In light of the parlous and desperate situation the US economy finds itself in it is edifying to note that Roubini was an economic advisor to the Government!
      Yes Keynesianism is all there is left now in the cupboard of economic wizardry of the ‘intelligentsia’ running the show.
      This Keynesianism is akin to taking a dollar from a kid then giving him four quarters back and telling him that he now has more wealth since he’s now in possession of four pieces!
      Yep, cutting the pie into ever smaller pieces by printing more and more confetti dollars to chase the same goods is making us all wealthier; we can print ourselves to prosperity, Mr. Keynes!

      Roubini deserves the Nobel Prize for Economics for fathoming that the gold bubble has burst, as much as warmongering, drone massacre Obama, and the country destroying EU deserved the Peace Prize!

      Being a professor and instilling innocent minds with such wisdoms leaves us no hope for the future, in fact the system is totally rigged in favour of TPTB who are all in the same boat of the Fiat Currency racket based on Fractional Reserve Banking owned by the Bankster/DC cartel, and its ensuing Keynesianism to oblivion.
      But the day of reckoning will come and it won’t be pretty; the economy is NOT improving Mr Roubini; all the stats are now completely meaningless, since they’re so perverted and falsified, often by a factor of four or more, that only a complete dunce, or a conniving colluder would proffer them as gospel and make pronunciations based on them!

      Humanity must be wrong for choosing gold as their tried and trusted choice as a store of their wealth, and Roubini must be right in deriding humanities’ choice and advocating cutting the same piece of pie into ever smaller pieces and telling the sheeples that they now are wealthier!

      Well the jury is in; the terminal decline of western economies desperately and underhandedly suppressing, deriding and selling their gold, and the unrelenting rise of the East and its wholesale buying of the only tried and proven store of wealth over five millennia is a cogent judgment on who’s got the right policies, and who’s reduced to resort to nefarious, obtuse and criminal means in a desperate attempt to keep a dying, iniquitous system afloat!

      We’ll send our kids to study in Austria!

    15. CommentedProcyon Mukherjee

      Rational expectations of the investment community have competing assets to anchor and de-anchor as a range of options unfurl in a volatile environment where predictability of growth and concurrent inflation has more than just a standard retinue of salacious explanations; expert commentaries have always fallen short of the movement in the variable in question as we have imponderables aplenty to choose from, the joker in the pack, exchange rates together with balance of payments situation cannot be ever predicted to point a denouement that commodities denominated in dollar has a unidirectional movement anytime soon. Why single out Gold?

    16. CommentedVangel Vesovski

      Are the crises really over? Japan is printing money and creating credit in an attempt to create goods price inflation. That will happen as the bond market gets destroyed and the yen becomes toilet paper. Why would Japanese citizens not try to buy physical gold instead of keep doing what they have been doing for decades?

      And who says that there is no 'inflation'? Central banks are flooding the market with liquidity. That does not have to show up as rising car or clothing prices because it can go anywhere. So far it has gone to prop up the biggest bubble in history; the bond market. When money flows out of bonds, and it will, it will go elsewhere. Given the fact that the bond market is so huge you could see all kinds of assets go up in price and the eventual spike in the price of consumer goods.

      Is the economy recovering? Can a jobless, debt-financed recovery be sustained for very long? I would argue that the central banks are creating even more instability as their operations bail out irresponsible speculators over the short term but destroy the purchasing power in the long term. And aren't those artificially low rates destroying pension plans as unfunded liabilities explode at a time when revenues cannot support the increase of those liability increases?

      On this issue I would rather look to economists from the Austrian School. At least they have been able to understand bubbles and have a coherent cycle theory that has made excellent predictions in the past. While gold could go down over the short term as paper sales overwhelm the action the demand for physical and the lack of inventory will cause prices to rise over the longer term to well above the $5,000 price that you think is so unreasonable.

    17. CommentedFrank O'Callaghan

      Why gold? Roubini points out that "gold remains John Maynard Keynes’s 'barbarous relic' with no intrinsic value and is used mainly as a hedge against mostly irrational fear and panic. He goes on to say that "all investors should have a very modest share of gold in their portfolios as a hedge against extreme tail risks". Gold is a talisman. It is a panic reflex about the nature of intrinsic value in a market that is fundamentally irrational and subject to surprises.

      Inadvertently, the key motivation to gold was stated by Alan Greenspan "In the absence of the gold standard, there is no way to protect savings from confiscation through inflation. There is no safe store of value". Of course Greenspan was as wrong as he could be, in that there are fundamental stores of value but few are as portable as gold. In the world where all are crushed between the confiscation by state bureaucracies and multinational corporations the inequality gap threatens the continued existence of the system.

        CommentedVangel Vesovski

        "He goes on to say that "all investors should have a very modest share of gold in their portfolios as a hedge against extreme tail risks"."

        If all investors had a modest amount of gold in their portfolios the price would be well over $5,000. How many people do you know that have any real gold in their portfolios?