Why gold and commodities are falling in the face of unprecedented quantitative easing?
Technically speaking, gold entered a bear market last Monday when it closed more than 20% below its high. But what a run it had; the price of an ounce of gold has risen roughly 700% since 2001, reaching $1,920 in 2011, as it became the ultimate safe haven from a very unstable world.
So what’s going on? For one, the risk premium that has been assigned to gold and other precious metals is coming off. That much is clear, and it’s being driven by a recovery in the U.S. that is, in turn, shifting investor sentiment. We’ve written about the tenor of economic conversation turning slowly from a post-crisis slog into one that is dominated by good news and only occasionally punctuated by bad news – the polar opposite of the situation only a year or so ago. Also contributing to this shift is receding fears of a Eurozone debt crisis, removed uncertainty regarding the election, and the budgetary bogeyman at least temporarily determined to pose no immediate threat. And then there is the simple fact that 700% is a big number and a decade is a very long time to run in essentially the same direction.
Sentiment is a tricky thing, especially in markets like gold. It can take a life of its own and go to much further extremes, as exhibited by price, than you think possible. For example: the contemplated sale of Cyprus’ gold reserves to partially fund its financial recapitalization, although small in monetary terms, has had an effect on investors far in excess of its actual value. They rightly fear that the decision could be a precursor to much larger European nations, with much larger reserves, which could resort to the same thing.
When you get right down to it, the monetary thesis on gold and other commodities is mathematically correct. The enthusiastic printing of tons of money by the world’s major central banks cannot help but debase their currencies, using the same Economics 101 logic that teaches basic supply and demand to college freshmen. The more something becomes available, the lower its price will be for a given level of demand. As the ultimate alternative currency, gold is the only globally accepted store of monetary value that can’t be easily created, and thus should rise as the supply of currencies goes much higher.
But this doesn’t mean gold can’t get ahead of itself, and that is a large part of what we’re dealing with. There is no way of knowing what the “right” price for gold is at a given level of QE, so it is impossible to draw a linear connection between X dollars in stimulus and Y price of gold. The market determines this relationship, and it is fraught with other intangible elements like risk premiums, inflation readings, the supply of gold from mines around the world, central bank sales, overall investor sentiment etc. It is certainly possible, if not probable, that current selling pressure on gold being generated from the change in investor sentiment is greater, at the moment, than the bullish effects of quantitative easing. Especially on Wall Street, perception is 9/10 of reality, and the herd is the most powerful force in finance once it starts galloping in one direction.
Plus, the effect on gold and other commodities from QE is no secret. Gold has been in bull market for ten years, and QE of some form or another has been around since the crisis began in 2008. That’s a long time to investors to price the expected effects of it into commodities, so it is certainly not unreasonable to postulate that the money printing by the Fed, the ECB, the Japanese, etc. may already have been baked in.
The old saying on Wall Street is to never catch a falling knife. It’s much better to wait until it lands on the floor, or at least catches a bid, to pick it up again.
(E-Mail ZT)
