Gold has fallen to fresh five year lows. There's been a lot of finger pointing at the cause of the slide. Here are some of the more popular reasons for the sell-off.
Interest Rates: The threat of the Fed raising interest rates has sent shudders into the precious metals market. But does it really make sense that a possible rise in the fed funds rate of a quarter percent or even one percent continues to push gold lower? Markets adjust to news and new expectations quickly. The price of gold has been falling since 2011, while the news that the fed is going to raise interest rates has been with us for only about a year.
Further, the Fed has explained that they would raise interest rates only when they are convinced inflation is moving higher. If inflation rises and interest rates increase approximately the same amount, the real interest rate remains unchanged. Therefore, there is no penalty for holding gold. Surely something else is going on.
I seriously doubt that the threat of a one percent– let alone a quarter percent – rate of increase in interest rates, is reason for gold to fall $600 as it has from its high if inflationary expectations rise. There must be another reason.
The Dollar: Many believe it is the rise in the dollar that has pushed gold lower, but that's true of all commodities. As the dollar rises, export prices rise and import prices fall. We have seen what this does to corporate earnings. Recent reports show major reductions in profits across the board to exporters.
But why aren't these export stocks, like Boeing (NYSE:BA) for example, down 80% like Market Vectors Gold Miners (ARCA:GDX) is? Most export stocks are faring well even with the ding they've taken in higher prices for their products overseas due to a higher dollar. Not so with commodities and commodity companies. Their prices have declined. Only resource companies have been crushed.
The dollar no doubt has a short term effect on commodity prices and corporate earnings, but companies generally adjust. This does not explain the implosion we're seeing now in the resource and materials stock sector. The question is: is the dollar pushing down resource and commodity prices, or is deflation in that sector and reflation from our competitors responsible for a stronger dollar? I think the latter is the case.
Commodity deflation: And this brings us to commodities in general. It's not just gold, or precious metals that are being decimated, it’s the entire commodities and resource sector. Is gold, which is usually the leader up and down in the commodity sector, trying to tell us something? I think so.
For years the world has been fighting deflation and recession. At times we see an improvement to disinflation and stagnation. And here in the US we even see a little growth and a little inflation -- very little. But like Japan, we see the constant attempts to achieve growth and return to 2% inflation, and the inability to do so. Japan suffered 25 years of recession, stagnation and deflation, and saw their currency rise to one of the most over-valued currencies relative to others in their history.
It wasn't an increasing yen that caused the deflationary recession in Japan. The deflationary recession came first and the rising yen followed. And low interest rates did nothing to help them, as was the case with record government expenditures on infrastructure spending. They tried it all. But through all this, no recovery followed. What they were left with was a stagnant economy and a debt-to-GDP ratio of over a hundred percent.
Gold's Safe Haven Status: Many point to the lack of reaction in the price of gold to recent geopolitical events as well as financial crises. Why hasn't the price of gold soared on the Russian invasion of Ukraine last year, and the Greek debacle this year?
Sometimes gold does soar, but these movements are usually short lived. During the Russian invasion, gold did rise. But as soon as sanctions were imposed, the Russian economy tanked and was soon followed by the eurozone falling into recession as world trade contracted.
The demand for commodities and resources in general fell and the world fell into a mild deflationary recession. Gold responded as did resource stocks around the world in general by turning downward with demand. As the Greek financial crisis grew, gold firmed up at first. But it was soon understood that the nature of the crisis was the debt burden of Greece, and the "solution" was to refinance the debt and/or default on it. This would be deflationary as money would be destroyed, not created. This is the trend around the world today.
There is little doubt that the slide in gold has been exasperated by poor sentiment as investors, traders, and speculators have turned extremely negative. But as I say, all commodities are falling. This is a warning. It is a warning of the reasserting of the recessionary-deflationary bias taking hold in the world.
It could be a more significant slowdown in China than meets the eye. It could be that the eurozone has been damaged more than we think by the Greek financial crisis, and the consumer is probably pulling in its horns. It could be that the US has run its course of six years of nonstop growth and stock market gains. Whatever it is, it’s worth watching.
As an investor that specializes in gold, silver, and the resource sector in general, I bought the fall of gold at 1180 in November of 2013 and rode it to the 1300 level and sold last July. I then bought again at 1140 in October and sold in March of this year at around 1200. I was stopped out of my major position just as the market began to tank. Since then I've been sitting on a very small core position of exploration stocks that are just now coming into fruition. These are my long term holdings.
I have told my readership to stay small and unexposed to the volatility of the present markets. Either gold is telling us that we are about to enter a severe deflationary recession, or that we are completing a severe correction due to the past deflationary recession around the world. Personally, I think it's the latter. But I'm not yet ready to commit funds and trade again. These markets are treacherous.
There will come a time when we can once again commit cash to this sector, and when we do, the rewards can be spectacular. Hopefully we are a lot closer to the end of this slide than the beginning; for if it's the beginning, it will affect all aspects of investing, all markets, and all economies throughout the world. I’m looking for the next major turn in markets to commit cash that is safely now on the sidelines and has been since March.