The primary feature of the financial markets this week – and, indeed, for many
weeks past – has been the very high level of volatility. Price swings far in
excess of anything considered normal in a given market have now become
commonplace, to the point that if they continue, the accepted notions of
“normal” will have to be adjusted or thrown out entirely.
best – meaning the most dramatic – recent example of this phenomenon has been
provided by the precious-metals market. As discussed in this column over the
years, precious metals are an especially difficult market to analyze because for
many people they have symbolic, totally irrational status. Hence the phenomenon
of “gold bugs” – people who believe in gold, although what exactly they
“believe” in varies.
In many cases, it is the quasi-monetary or
quasi-religious concept that gold has functioned as a store of value for
thousands of years, which makes it far superior to “fiat” money issued by
governments, because the latter are subject to dilution (via inflation) and even
destruction or confiscation at the whim of the ruling person or junta.
variant or supplementary aspect of this belief syndrome, which is more
utilitarian and perhaps more rational, is that gold is a useful or even
essential component of a diversified investment portfolio. In inflationary
times, or even facing the threat of inflation, most financial assets will lose
But real assets such as commodities and real estate, and
especially precious metals, will retain their value.
In the face of the
unprecedented monetary expansion in recent years, most analysts have predicted
that inflation will surge and not a few have warned of “inevitable”
This view has led to a huge rise in the number of people
coming to accept and acting upon the beliefs noted above. The result: After
hitting a 20-year low in 1999 at around $250 an ounce, gold’s price rose for 10
successive years from 2002. This uptrend climaxed in early 2011, when gold
prices climbed over $1900, more than double their previous historical peak in
nominal prices, and silver soared briefly to $50 an ounce, equaling the level
touched in the previous silver mania in 1980.
Since then, central banks
have continued to inject staggering sums of money into their flagging economies,
but inflation is still nowhere to be seen – and precious-metals prices have been
in retreat. Until recently, this retreat was a gradual and orderly affair, but
two bouts of massive selling – the second this month – have turned it into a
rout. On Tuesday, gold prices again shed over one hundred dollars in the course
of a single trading day, falling close to $1,200 an ounce, or nearly 40 percent
below the 2011 record level. Silver, which traded down to near $18 an ounce, is
almostthirds below its peak.
The gold bugs are in total disarray. After
crowing about how gold must rise to stratospheric levels (first because the
Chinese central bank would switch a chunk of its currency reserves from dollars
to gold, and then because ordinary Chinese, not to mention innumerable Indians,
were lining up to buy physical gold, to the point that the Indian government had
to clamp down on gold imports), they are at a loss intellectually, although not
financially, since most of them bought at much lower prices. The more rational
among them understand that the rise in medium- and long-term interest rates is
the kryptonite that is killing gold.
But the speed of the collapse is a
technical phenomenon rather than a fundamental one: So much of the gold buying
in recent years has been made on borrowed money, and the margin calls demanding
more collateral on their loans issued to the speculators as the price falls have
triggered forced liquidation, sending the price plunging and creating a negative
loop of further forced sales, further drops and so on.
Thus endeth all
prolonged booms, in spectacular busts made more dramatic by the widespread use
of leverage and of sophisticated speculative instruments (such as ETFs based on
gold or gold shares). It is more than likely that the price slump will soon
reverse and a sharp rise will ensue.
But that won’t help because the
magic has gone out of precious metals for at least another generation. The true
believers will mutter about how TPTB (The Powers That Be – in normal parlance,
the government and its agencies) have brought gold low by deliberate and
dastardly manipulation, conveniently ignoring how the dastardly manipulation of
interest rates allowed gold to soar in the first place.
But the muttering
won’t repair the precious-metals market, which is rapidly losing its liquidity.
The vicious circle now at work there – and soon to be at work in many other
markets – is that volatility leads to loss of liquidity because most people are
scared to enter volatile markets, and loss of liquidity causes increased
volatility. To sit through that and think only about the long term requires not
just strong belief but also strong nerves.