By Louis Golino for CoinWeek
Ever since last Wednesday, June 19, when gold began its second major drop of the year, market pundits and analysts have been weighing in on why gold has declined so much and what the prospects are for the future.
The decline was set off by a widely-anticipated Federal Reserve Bank statement that said that provided the American economy continues to improve in the coming months, the Fed may begin reducing its bond buying program known as quantitative easing, or QE, later this year and could end it in 2014.
Nothing about that is new or unexpected, and the fact that it sent stocks, bonds, and precious metals down so sharply is a clear sign of two things: one, the economy is much more fragile than most people realize, and two, all of these markets have been on a kind of sugar high driven to a considerable extent by the easy money of QE.
If this is what happens when the Fed simply re-states what it has been saying for months, imagine the chaos that is likely to ensue when it actually does end QE, and when it eventually raises interest rates. Both actions will happen eventually, but only after the economy is on much firmer ground and inflation picks up as the economy does so.
The notion, expressed by some writers, that QE can never end is in my view absurd for it implies that the economy will never get better, in which case we are all really doomed, and it also overlooks the fact that the Fed simply cannot endlessly expand its balance sheet. But I do believe that easy money will be around for longer than most people currently believe it will, which is part of why I see the market reaction of the past week as so irrational.
As for gold and silver, the past week has been especially brutal. Gold is down to the level is was at in September 2010, and is having its worst quarterly performance since 1920 and its biggest decline since 1981.
Gold and silver are without question hugely oversold, and the precious metal markets are engaging in liquidation driven by fear rather than reason, but in the near term I believe the down trend will continue as more people exit the trade and downward momentum feeds on itself.
$1,000 would appear to be the floor, as that is the average current cost to produce gold. When it goes below those levels, mining companies will stop mining it. While it is true gold prices are driven more by market sentiment than by supply and demand fundamentals, I do think $1,000 will be the key level to watch.
The current sell-off is different from the one that started in April because this time so far physical buyers are not jumping in to the same extent.
That can be seen in several ways. In India gold import taxes are up sharply and the wedding gold buying season is over. China has already stockpiled a lot of the yellow metal and is dealing with a slowing economy and liquidity issues.
In addition, so far dealers and the U.S. Mint are not reporting backlogs in supply and are able to meet current demand. I think most buyers realize prices are likely to fall further, so there is a weight and see attitude.
If you are a long-term investor, there is no need to panic.
This is a good time to add to your holdings at attractive prices, especially since premiums remain reasonable, unlike in the spring. The same is true of silver and silver premiums.
If you have been waiting to finish your gold type set, or buy that MS65 St. Gaudens double eagle you have always wanted, now is a great time to do so as long as you are not using money you need in the short-term.
Another factor that must be thrown in the mix is a disturbing trend, especially in Europe, to discourage precious metal ownership.
First, on May 23 France quietly passed a new law that received no media attention within the country, which makes it illegal to send or receive precious metals by mail. In particular, because of the new law, UPS, FedEx, and French mail are not allowed to ship precious metals to or from France.
This strikes the Coin Analyst as an odd move since for one thing the French Mint sells precious metals coins on its web site to French people and foreigners, though perhaps numismatic coins are exempt.
Second, as Barry Stuppler reported in his “Weekly Precious Metal and Rare Coin Report” for June 17, since September 2011 Austrian banks have been forced to restrict precious metal sales and to limit purchases to no more than 15,000 euros ($20,000) at a time.
He also notes that FedEx recently starting forbidding people in the UK and Germany from sending or receiving precious metals by mail.
In Mr. Stuppler’s views these legal restrictions on precious metal ownership have the potential to spread to other countries and “could easily go worldwide,” which he sees as another reason to take advantage of current attractively-low prices.
I am neither convinced this will become a global trend soon, nor do I see them, as many other commentators do, as a stepping-stone to gold confiscation, which I think would be impossible to implement today. But European governments already have more record-keeping and other requirements for precious metal purchases (such as no cash transactions in France) than many other countries do, and these are definitely developments to watch.
Another useful perspective is provided by metals analyst Jeffrey Nichols (http://nicholsongold.com), who writes about the “cloud of bearish expectations” that currently hangs over gold.
He points to the obituaries for gold that are being hastily written by those who see a future of nothing but low inflation, a rising dollar, low interest rates, and a Europe that gets through its sovereign banking crisis as heavily indebted countries move to sell off some of their central bank gold. This is a view that would make Dr. Pangloss proud. For those not up on their French literary references, Pangloss was a character in Voltaire’s Candide, who always saw the world through rose-tinted glasses.
As Mr. Nichols points out, the largest central bank gold purchases by far are those of Russia and China, and neither of them has plans to sell that gold for a very long time. The same is true of the rising middle classes in the emerging market economies, where buying and holding gold for the long term is a cultural tradition and not just a way to hedge against rising inflation in those countries.
As Mr. Nichols sees it, demand for gold in these countries “will be enough to move the metal’s price higher even if economic and investment conditions in the United States and Europe remain inhospitable to gold.”
There are a lot of myths about gold, such as the view that it does best as a hedge against inflation. In reality gold has done best when inflation remained low, at least in the U.S., over most of the past two decades.
Critics of QE have been saying it will create hyper-inflation since the program was launched. Time will tell whether it contributes to higher inflation when rates start moving up, but what is undeniable is that QE debases the value of the dollar. And currency depreciation may be the most important long-term shaper of gold prices.
At the moment all the major currencies of the world are in a race to the bottom in which each country seeks to keep lowering the value of its currency to promote that country’s growth through increased exports. Besides, now they have the extra incentive of devaluing to reduce the value of their debts.
It is true the dollar is temporarily stronger than other depreciating currencies, which always happens when markets go crazy and investors seek refuge in the dollar, but as consumers continue to lose purchasing power with their paper dollars, they will increasingly understand why a weak dollar matters.
I was at a dinner party recently and when I explained that I wrote about precious metals, someone I was speaking with seemed to take pleasure in pointing out that gold was down this year, apparently unaware that no asset class can always be up, as gold has been for almost every one of the past 20 years.
Louis Golino is a coin collector and numismatic writer, whose articles on coins have appeared in Coin World, Numismatic News, and a number of different coin web sites. His column for CoinWeek, “The Coin Analyst,” covers U.S. and world coins and precious metals. He collects U.S. and European coins and is a member of the ANA, PCGS, NGC, and CAC. He has also worked for the U.S. Library of Congress and has been a syndicated columnist and news analyst on international affairs for a wide variety of newspapers and web sites.