Still, a gold market bubble, which basically showed the so-called typical characteristics and which was even more pronounced than that of the NASDAQ or that of the oil price, is not unprecedented.
LONDON(BullionStreet): In mid-April, gold suffered the sharpest daily decline in more than 30 years. Some market observers argue that the bubble has burst. Commerzbank have compared the current gold price trend with previous bubbles and argue against the view of bubble formation. The fundamental environment of ultra-loose monetary policy, low real interest rates and the threat of a global depreciation race continue to speak for a rising gold price. Furthermore, the prices of silver, platinum and palladium, which have likewise fallen sharply recently, should pick up again in the course of the year.
The price of gold virtually collapsed in mid-April. On a single day, gold plunged by 9%, which was the strongest daily decline in more than 30 years. Within two trading days, a troy ounce of gold was down by more than U.S. $200. In absolute terms, this was the sharpest price decline ever. At roughly $1,320 per troy ounce, gold temporarily dropped to the lowest level in more than two years. However, the landslide was not driven by a stronger dollar. In the same period, the gold price in euro was also down by some 200 euros per troy ounce to roughly 1,000 euros, which marks the lowest level since May 2011. Only silver suffered sharper losses than gold.
Following the recent landslide, the gold price has temporarily dropped by 30% from its September 2011 record high of $1,920, and by a good 25% from the interim high in October 2012. Against this backdrop and in the light of the recent downtrend, many market observers argue that a bubble has burst. After all, the price of gold was on a continued uptrend between 2001 and 2012 and had increased seven-fold in the meantime. This can by no means be justified by the general (rather moderate) price trend, as the real gold price – adjusted for the US consumer price index – has also risen markedly and continues to be well above the long-term average even after the recent plunge. However, a bubble is mainly characterized by the last price rise showing exponential growth, directly followed by a sharp price slump.
In the past fifteen years there have been two known bubbles on the financial markets that meet this criterion: During the New Economy bubble and the oil price bubble, which burst in March 2000 and July 2008 respectively, – equities/prices remained on a continued uptrend over a multi-year period and increased exponentially at the end. In the seven months preceding the all-time high, the NASDAQ Composite nearly doubled. More or less the same can be said for the oil price in the first half of 2008. Gold, on the other hand, edged up by “just” 30% between January and early September 2011, which was practically on a par with the average annual price trend up until 2010.
Immediately following the record high, both the NASDAQ and the oil price went on a sharp downturn. By year-end 2000 - within nine months - the NASDAQ Composite halved, and oil recorded the same losses in just three months. For gold, however, the picture is different. Between the all-time high of September 2011 and the recent plunge, 19 months passed, and in the three months following the record high, gold fell by a "mere" 20%. A bubble, which bursts after such a long time, would be a quite exceptional event.
Still, a gold market bubble, which basically showed the so-called typical characteristics and which was even more pronounced than that of the NASDAQ or that of the oil price, is not unprecedented. Back then, the price of gold doubled within less than two months, and two months after marking the record high, it had nearly halved again. Given the evident differences between this trend and that emerging in the last three years, a comparison with the current situation is, in fact, superfluous.
Like in 2011, investment demand back then also constituted around 40% of total gold demand. But, according to the World Gold Council, the share of Europe and North America this time amounts to less than 50% of investment demand, which is down markedly from the bubble phase (over 70%). The share of China and India, on the other hand, rose to almost 40% last year, whereas it was negligible 33 years ago. Demand from these countries ought to have been much more sustained than that from the western industrialized countries, as they are not seeking to hedge against the collapse of the financial system. Instead, rising incomes and the inflation rate, which is generally higher in this region, ought to have been major investment motives.
There is another big difference between 1980 and today: the price fall then was triggered by a considerable tightening in US monetary policy. The US key interest rate was raised from 11.5% to 20% between October 1979 and March 1980, which triggered a sharp rise in real interest rates and made gold less attractive from an investor’s perspective.
An earlier end to the Fed’s asset purchases is possible now, but imminent rate hikes by the Fed are out of the question, never mind on a scale witnessed 33 years ago. It should also be noted that gold continues to account for only a small proportion of the portfolios of private investors despite the ongoing price rise in past years. According to the World Gold Council, private gold holdings accounted for only about 1% of global financial assets in June 2011. Even considering all the gold already mined, this still amounts to merely 6% of global financial assets.
Given the arguments against a gold market bubble, gold is unlikely to remain on a sustained downtrend. Private investors already regard the current price levels as buying opportunities. Following the recent decline in prices, demand for gold coins and bars has already increased visibly. US gold coin sales topped 100,000 ounces in one week, an amount that is not often sold in a whole month. In China, too, traders report an “exceptional” physical demand. In the key gold-consuming country, India, demand for gold should also receive a strong boost from the price decline.
The current situation is more reminiscent of the temporary sharp downtrend in October 2008 than of other bubbles. Back then, the price of gold also dropped by around $200 per troy ounce within two days, but recouped the losses over the coming three months.
In autumn 2008, the downslide of gold also coincided with a decline in commodity prices and a downward revision to global growth expectations. On the back of this, investors‘ strong fears of rising inflation abated visibly. About 4.5 years ago, like in recent days, mostly short-term investors backed out of the gold market, but then returned in the following months.
The fundamental environment continues to be positive for gold even after the price slump. The central banks in the emerging markets have been buying gold for three years. With the proportion of gold in currency reserves of the emerging countries still at very low levels, central banks are likely to use the lower price level for further buying in the coming months.
A further factor supporting prices is the ultra-loose monetary policy of central banks in the industrial nations. Real interest rates continue to be extraordinarily low as a result, which suggests that investment demand will recover in the course of the year. Furthermore, the recent decisions of the Japanese central bank have sparked fears of a global depreciation race among many financial market participants. This should also boost the demand for gold as an alternative currency.
This time, however, it might take longer before gold goes on a new uptrend, as the sharp losses have shattered the status of gold as a safe haven and a store of value, especially as the exact backdrop of the price slump is still unclear. Furthermore, gold ETFs are still recording outflows; this amount to over 300 tons since the start of the year, meaning that all inflows since November 2011 have now been reversed. An exaggeration appears to have formed last year in this segment of the gold market at least and is now being corrected. On the back of this, investors are likely to remain cautious in the near term. Over a three-month horizon, the bank therefore expect gold to stabilize at $1,400 per troy ounce. In the second half of the year, investors‘ faith in gold is likely to return gradually. For the fourth quarter, Commerzbank analysts reckon with an average gold price of $1,650 per troy ounce.
Other precious metals are being pulled down with gold, especially silver, which has plunged by as much as 20% within two trading days and likewise fell to a 2-year low at $22 a troy ounce. Platinum and palladium both posted losses of 10% within two trading days, with platinum falling to its lowest level since the end of 2011 at $1,375 a troy ounce and palladium being as cheap as last in November 2012, at just under $650 a troy ounce.
Commerzbank also revised price forecasts for silver, platinum and palladium downwards, but still expect rising prices in the course of the year. Silver should climb to $30 a troy ounce by the end of the year, as it has taken the sharpest plunge of the precious metals and therefore has the greatest potential to recover. The bank’s analysts envisage platinum rising to $1,700 a troy ounce and palladium climbing to $800 a troy ounce.