In an economic bubble, at a certain point pricing gets emotional and disconnects from whatever the original reasons were that kicked off the trend. Add easy money and the bubble gets really bubbly. The price movements attract attention and generate media play and then things really cascade upwards.
I’m not a gold bug and probably the last person to give guidance about gold. Though I know a thing or two about bubbles and this one is no mystery.
Gold has been bubbly in a special way.
The housing market boom and the NASDAQ dotcom boom bubbled up because of positive sentiments like, “Housing can never crash!” and “There’s no dotcom bubble because Alan Greenspan sees no signs of Irrational Exuberance!”
Gold on the other hand got bubbly because of negative sentiments like the fear of inflation and economic uncertainty.
Gold is traditionally a hedge against inflation and fear, or fear of inflation, which is precisely what the various rounds of QE kicked off: massive expansion of fiat currency.
Fear and panic were under the surface during and immediately after the recession. For the first time since the Great Depression, the US saw bank runs. Americans were having to line up for gas. Unprecedented unemployment and personal bankruptcies were rampant. Greece, Spain and Italy were close to collapse. Defaults loomed while fiat currency was reaching unprecedented heights. This was all happening AFTER the Great Recession ended.
In response to the persistent and extreme economic instability, gold prices continued to race up. From 2009-2011, the two years following the Great Recession, gold prices shot up 75% and they kept rising.
By late 2012, however, global economic crises were retreating. Central Bank coordination succeeded in calming markets. Since then gold prices have drooped 30% from $1800 to $1200.
What Happens Next? The Fear Trade Unwinds
Gold prices remain elevated – up 3X since 2005. Very little of this comes from inflation.
Quantitative Easing (QE) did not lead to unusual inflation. For proof, fans of the Federal Reserve like Paul Krugman regularly point to the CPI (Consumer Price Index) which has averaged ~2% per year since QE began. Critics jump up and accuse the Fed fans of cherrypicking data. Specifically that the CPI strips out precisely those things that would reflect inflation like food and gas.
So let’s take the critics’ concerns into account. Looking at inflation in meat, poultry, fish and eggs (per the Census Bureau), we can see the change in prices for the last three business cycles (from the end of the previous recession to start of the next recession):
- 1991-2000 (9 years): 22%
- 2001-2007 (6 years): 22%
- 2009-2014 (5+ years): 22%
Ah-ha! The critics were right about higher inflation. It took 10 years for prices to grow 22% in the 1990s and we hit 22% in just five years from 2009-2014. That’s 2% annualized inflation in the 1990s versus 4% over the last five years. The pace has doubled.
Is that so worrisome? It’s nowhere close to the fear of hyper-inflation, much less major inflation.
Additionally, the faster pace of food and gasoline inflation comes from a general global trend towards competition for basic resources. Indian and Chinese diets and purchasing power have expanded. They are eating more meat and burning more gasoline (China is now the biggest auto market in the world, for example). The rise in non-US demand pushes up prices. Today’s inflation is about the same as it was in the previous cycle. Adding to that global trend is the 2014 California drought, further boosting prices.
Looking back we can say that QE created no unusual inflation, but nobody knew that at the time. What we knew was major financial panic.
All this boils down to one key point. Gold has been a fear-based trade, and fear is dropping.
The Retail Market is Propping Up Gold… For Now
From 2008-2012 the Federal Reserve initiated three rounds of QE. Asset prices surged following each round. Loose money has a way of doing that.
Gold prices began to fall in early 2013 as talk of QE tapering picked up. Monetary tightening was now on the horizon.
For the gold-inflation trade, the bets had to shift. An end to QE meant a tilt away from an expanding fiat currency and against owning gold. Tighter monetary policy is anti-inflation and anti-gold for the gold-as-inflation-hedge crowd. Suddenly many top hedge funds began to reduce gold ETF holdings. (Some might say that they were anticipating a drop in gold prices, but it’s more likely they created the price drop simply by exiting the market.) Hank Paulson stuck around to hold the bag while George Soros and others began to exit.
For the gold-fear trade, the end of QE was an official proclamation that the Fed had slain the bad-news economic dragon. As big (smart) money left the table, retail (dumb) money kept buying.
Google Trends is Your Friend
Google Trends is a tool to analyze everyone’s web searches. Type in a word or phrase and Trends will report the frequency that it appeared in Google searches. It turns web searches into a gauge of interest and sentiment, which is another way to predict consumer and household behavior. Trends let’s anyone track thousands and even millions of people’s interest and concerns and it can be fine-tuned for a particular time period and location in real-time.
Google Trends says people are much less afraid. Start with general interest in gold.
Gold searches are a coincident indicator. People searched on the word “Gold” in response to the media and a surge in gold prices. Back in 2008, when gold prices began to jump, so did Google searches on the word. Big jumps in searches accompanied big moves in prices.
Peak Google interest in late 2012 corresponded to peak gold prices.
Interest today has fallen to 2011 levels and below, which corresponds to a gold price far below $1200. It was closer to <$1,100.
Positive Household Sentiment is Bad for Gold
Google Trends shows no support for the fear-based trade.
Searches for key words like ‘Recession’, ‘Unemployment’ and ‘Bankruptcy’ are down sharply. Fear is down to pre-recession levels when gold was $600. That would be a 67% drop in price, about what happened to the NASDAQ. With QE gone, more sellers than buyers (in the form of hedge fund positions) and with fear of economic uncertainty down, why wouldn’t gold prices return to near 2006 levels?
Inflation and Interest Rates: This is Where it Gets Interesting
Until recently, searches were dropping for the words ‘inflation’ and ‘interest rates’. Though it is rising again as concern is increasing.
Apparently inflation expectations are rising. Apparently interest rate growth expectations are rising.
Some of this may be self-fulfilling. The media has been spinning the specters of inflation and rising interest rates for almost a year, since the end of QE was announced. It could provide some near-term support for gold as an inflation hedge.
However the lack of follow through from inflation and interest rates may find that this support wanes.
An investor’s best bet is to continue watching the trends. That should be a key indicator on any future large moves in gold.