Ahead of Friday’s all so crucial job numbers, the markets seem to have taken a bit of a breath. This rally in the US indices which led to the Dow and S&P to gain 11 and 10 percent respectively in the first quarter amounted to the best start to the year since 1998. Gold, quite simply, has become an unpopular trade when there exists this present opportunity in the US markets, and this is without deference to the fundamental reasons for what is driving them higher.
Societe Generale released a special report this week that’s caught the attention of many commenting on what they dub “The End of the Gold Era.” Further, their bearish outlook has the price of gold to finish the year at $1,375 per ounce. This differs significantly from estimates amongst Bloomberg traders that are looking for $1,750/oz., but what Societe Generale sees coming is the beginning of a long and slow bear market. They are of the extreme, but commodity divisions at some of their fellow investment banks followed suit as they are not alone in forecasting lower gold prices in the two years to come.
Many gold bugs attribute lower prices to the banks suppressing the price of the metal in order to cover positions from a gold carry trade. This conspiracy theory may potentially be valid, but lacks originality as it has been used in the past, and as recently as the UK Treasury announcing in May of 1999 that it would sell half of their gold reserves. The very announcement sent the metal down to $250/oz. The difference, however, was in that short time ago there was still a resurgent US dollar, and no need for an alternate safe haven.
The reign and outlook for the US dollar now though differs significantly from a decade and a half ago. For good reason, in the late nineties, gold had lost its popularity as it did not serve the same role in international finance that it does today. For many of the developing central banks around the world it is the hedge against holding US dollar assets, and that is why central banks opt to hold it in accordance with their US reserves. It is the same reason an individual investor might hold gold; it’s a hedge and not sure thing. Even with Germany as recently as 4 months ago, the country acted to repatriate a portion of their gold—they brought it home, they weren’t selling.
Amidst lower prices for gold bullion, the story has not changed. Japan’s central bank announced this morning that they were to double their monetary base over the next two years in order to spur inflation. The US Federal Reserve has a balance sheet thrice what it was before the latest global recession, and there is no event in economic history that can provide any indication for how they will unwind their holdings. That’s just rationale for diversifying from an inflationary or monetary perspective. With the degree of capital controls not only going into place in Cyprus, but also across the Eurozone as a whole, an investor has to wonder how stable our financial system truly is.
When there is still this level of uncertainty in the global market place, there is still reason to hold a little gold. In the very scheme of things, a positive quarter is great, but the question is can it sustain. For the time being, only a contrarian would say no. But I guess the contrarians were the ones buying gold at $250/oz. in May of 1999 and not selling it.