Wednesday, October 15, 2014

Opinion: The rise and fall of Gold

Pricing of any commodity depends on supply and demand of it. But for gold it does not appear so, at least in last 8 years. And gold is no ordinary commodity. It is considered as ‘store of value’ for many centuries. When the fiat currencies fail to store value, gold comes to rescue and acts as an alternate currency. So the pricing of gold depends on what is happening with the currencies in circulation all over the world as well. And the biggest of them is USD. The Federal Reserve, central bank of US did few experiments with its monetary policy and gold had to respond to that.

Look at the following two charts. Gold had a fantastic run from 2008 to 2012. It appreciated from $800/troy ounce to $1800 which made many wonder if it will ever end its dream run. The Indian women (including grandmothers) who advocated buying gold all the time and at any price point appeared to possess more wisdom than anyone had thought. But gold too topped out and it saw price erosion despite few shouting ”It is a good time to buy” and now it is at 4 year’s low price.
Look at the other chart below it. It is the chart of US 10 year Bond Yield. It bottomed out when gold was at its top in 2012 and both reversed their directions from there on wards. So gold pricing was inversely proportional to bond yield in the last 8 years. And bond yield depended upon the demand and supply of the underlying currency, USD.

Rise and fall of gold

After the financial crisis in 2008, Fed announced Quantitative Easing (QE) a way of pumping to more dollars into the system by buying treasury bonds, a bull run in the gold had begun. Interest rates were kept to minimum to help trigger the economic growth. That means dollar supply was more than gold so one has to pay more dollars to buy the same quantity of gold. QE2 came during Nov 2010, quickening the rise in gold and reach an all-time high. QE3 began at the end of 2012 but it was intended to but only mortgaged securities unlike QE1 and QE2 which were aimed at buying treasury bonds. So it did not help gold to appreciate. As the speculation of QE tapering began in the early 2013, downward journey in gold prices started and by the time Fed confirmed its intentions to begin taper at the end of 2013, gold had given up most of its gains and bond yields which were suppressed were popping up again.


Expansion of balance sheet at Fed would stop from next month as bond buying program ends. So the focus is now shifted to the other policy measure Fed controls, interest rates. Fed has not yet revealed its plan and wants to keep rates low until US economy sees further revival but that time line may not be very far from here, probably 6 months to an year. And the rise in rates is expected to be slow and gradual as well. Until then gold prices are likely to remain in a range. So around the time rates begin to go up, gold may see its bottom and gradually begin to rise. Chart suggests it may not fall below $980 which may act as a strong support. For gold lovers, mid to end of 2015 might be the beginning of bargain buying opportunity.