Recession fears hit gold hard
Many investors have purchased gold as a hedge against inflation. Growing signs of recession have caused alarm, however, turning buyers into sellers.
In response, the price of gold has fallen substantially, dropping below important technical support levels. What should investors do?
A hedge against inflation is not the only reason for acquiring gold. There are five other reasons that justify an investment in the precious metal turbulent times.
Most people consider gold to be an inflation hedge. In recent times it has been, but only over certain periods. Because many people forget to adjust for inflation, the myth continues that gold is a constant inflation hedge.
Last week, minutes of the Federal Reserve Board's Open Market Committee indicated there is increasing disagreement as to how long quantitative easing (QE) measures by the government, such as an artificially low prime lending rate, should remain available.
In addition, cuts in government spending — referred to as “sequestration” perhaps because it doesn't sound as harsh — have reentered the political discussion. Both carry recessionary implications.
Furthermore, economists at Shadow Government Statistics say government figures show the United States is still in recession despite political talk to the contrary. The European Union, United Kingdom and Japan also teeter on recession, according even to official figures.
These growing signs of recession are squeezing out many investors who invested in gold as an inflation hedge.
In a recession, assets, including commodities, fall in price as cash rises in value. Gold, though, is not merely a commodity. It is the ultimate form of cash. This creates an inherent dichotomy.
Gold defends against currency debasement. Closely linked to inflation, buyers view Fed talk of an early end to QE and rising interest rates as strengthening the dollar, encouraging gold sales.
Investors buy gold for portfolio diversification. When financial markets fall, they sell their liquid gold to finance margin calls.
Major traders buy gold on the basis of supply and demand. China, the world's largest producer, sells no gold.
From a peak of $1,927 an ounce in 2011, gold's price decline has prompted producers to abandon marginal deposits. Angelos Damaskos of the Junior Gold Fund was quoted in The (London) Telegraph as saying this strategy will “inevitably cause a significant decline in global production.”
“Should economic events take a disappointing turn,” he added, it could cause a “global supply crunch” that could potentially send gold to $2,000 an ounce.
Most importantly of late, gold is hoarded as insurance against political, economic or currency collapse. When catastrophe strikes, it usually is without warning. Extended bank holidays, market closures, foreign exchange controls and other measures occur overnight. Investors have little or no time to escape, even from positions held in normally liquid assets.
Gold has survived throughout recorded history as the ultimate form of money. Gold surplus nations such as China and Russia are aggressive buyers.
As the world struggles to balance the forces of economic recession against currency collapse, investors deciding whether to buy gold should consider that the ultimate insiders — the central banks of most major countries — own thousands of tons of it.
John Browne, a former member of Britain's Parliament, is a financial and economics columnist for Total Trib Media. Email him at firstname.lastname@example.org.