GOLD BUGS CRUSHED

It is always amazing to me how little we learn from history, both that of the western world and our own.  Take the real estate collapse that led to the great recession of this century, for example.  It was fueled by bank sales of ‘Collateralized Debt Obligations’ to buyers willing to believe that they had value when in fact they were dominated by sub-prime mortgages on real estate sold at inflated prices - a ‘sure thing’ bankers insisted.  Unremarkably, this sort of a scam is as old as the notion of stock markets, beginning with the ‘Great South Seas Bubble’ of the early 1600s.  In like manner, trading commodities at prices exceeding their utility also dates back to the same period of time beginning with (of all things) the ‘Tulip Bulb Bubble’.  So the dramatic fall in the price of gold should not have taken anyone by surprise.

If you’ve not followed this drama, the bare bones facts are these.  About a dozen years ago gold sold for in the neighborhood of $260/ounce.  This price kept many mining operations shut down as the cost of extracting it would be greater than the price it could obtain in the market.  The market, of course was driven by demands divided, roughly, into industrial demand, about 25% of annual production, and the rest, divided in turn, into gold used to make jewelry and gold that was hoarded.  In India, at that time consumer of more than a quarter of the world’s annual gold production, the line between gold hoarding and jewelry was ill defined; as much gold the consumer looked upon as a ‘currency reserve’ was fabricated into crudely made jewelry, the better to keep an eye on it.  In a very real sense, the value ascribed to gold was probably greater than any value derived from its utility; but the differential was not huge.  By the end of April 2003, the price of gold had risen by about 29% over its 2001 market price; a year later the price of gold had crept to about $390/ounce, a 50% increase over its 2001 level.  Soon, this sort of increase would attract ‘hot money’.

Hedge fund operators began to take an interest in gold as a ‘quick fix’ for out of ‘whack’ balance sheets at the end of a quarter.  Invest a few billion dollars in gold (using automated computer trading at the speed of light) and the price of gold would jump up enough, usually in the range of 13% to 14%, to make the old balance sheet look good, then dump it after the need had passed. Interestingly enough, between 2006 and the end of 2011 this rhythmic range (13% to 14%) in the price at which gold was traded remained largely constant.  What changed was the arrival of the “gold bugs”.  These were individual investors who bought and held gold for long term profit; one can justifiably call them speculators.  Ironically, this was often out of a belief that fiat currency was doomed to lose its value.  I say ‘ironically’ because their faith in gold’s value was fueled by manipulation and speculation - the same sorts of actions that affect that other ‘commodity’ detached (like gold) from practical utility - fiat currency.  Ultimately, in the late summer and early autumn of 2011, the price of gold flirted with $1900/ounce; all without any increase in its practical utility.  Like the captain of the Titanic, the gold bugs were roaring full steam ahead into danger.

It came not in a collision with an iceberg; rather it was a collision with that other ‘commodity’, fiat currency, namely, the Euro.  Five Eurozone countries fell economically ‘ill’ in the wake of the ‘crash of 2008’ and required ‘bailouts’ by the rest of the zone to keep from defaulting on their debts.  Among these, the faltering, running sore of Greek bailouts clearly raised some questions for hedge fund managers; and the price of gold fell from its dizzying heights of September, 2011 by about 19% (to about $1535/ounce) at the end of December.  Once burned, twice shy; and interestingly, the swings in the price of gold dropped to an average of less than 2% - hard on speculators.   In late 2012 things got worse.  Banks in Cyprus, another Eurozone economy, had ‘invested’ quite a bit of their depositors’ money in Greek bonds; and as these were devalued, the question of whether Eurozone banking insurance would bail depositors out came into focus.  The answer was equivocal; the Euro shook; and in the denouement of this crisis, The European Commission (on April 9, 2013) declared that Cyprus had agreed to selling off a bit more than $500 thousand in ‘excess’ gold reserves to keep from defaulting.   The chief of the Cyprus central bank demurred, insisting that only he could authorize the sale of gold; and within a week the world price of gold fell by more than 12%.  And if that didn’t put an end to gold fever, on the 15th, American investment banker Goldman Sachs announced that it anticipated the price of gold to fall to about $1250/ounce by the end of 2014.  In a word, if you had bought gold after the end of August, 2010, you could expect to take a loss if you tried to sell it.  So much for the value of gold as an investment.

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