The continuous upward trend in gold price in 2010 can be partially explained as
a market response to post-crisis economic conditions created by reactively
loose monetary policy developments and aggressive market intervening measures
by
both the central bank and the Treasury in the US. This approach was duplicated
in varying degrees by many other governments in the Group of 20 (G-20).
While both the Barack Obama administration and the supposedly independent
Federal Reserve argue forcefully that quantitative easing was an unavoidable
emergency measure to prevent a pending total meltdown of the financial market,
the equally unavoidable consequent post-crisis stagflation for up to a decade
is reluctantly acknowledged by all.
Gold remains a safe-haven asset much sought after by investors in a market
increasingly sensitive to deliberate and consequential fiat currency debasement
by central banks through quantitative easing (QE), a term that describes the
process of central bank injecting money into the market by buying debt from
distressed financial institutions with money the central bank creates ex nihilo
(out of nothing), resulting in an expansion of the central bank's balance
sheet. This was evidenced by sustained net inflows of funds into all sorts of
gold-based investment vehicles.
Bernanke denies quantitative easing
However, in the Stamp Lecture at London School of Economics on January 13,
2009, Federal Reserve chairman Ben Bernanke, about three years into office,
asserted that the Fed's approach to supporting credit markets during the
financial crisis was conceptually distinct from quantitative easing (QE), the
policy approach used by the Bank of Japan from 2001 to 2006. The Fed's approach
- which Bernanke suggested could be described as "credit easing" - resembles
quantitative easing in only one respect: both approaches involve an expansion
of the liability side of central bank balance sheet without adding balancing
assets.
Accordingly, Bernanke asserts that in a pure QE regime, the focus of policy is
the quantity of bank reserves, which are liabilities of the central bank; the
composition of loans and securities on the asset side of the central bank's
balance sheet is merely incidental. The implication is that the balance sheet
can stay unbalanced due the fact that the asset side is a phantom number the
underlying basis of which is the central bank's newly created money.
Nevertheless, QE is now the term generally used in the financial press to
describe Fed "credit easing" monetary measures taken during the current
financial crisis. The Fed's past, current and future stimulus monetary measures
are popularly referred to as QE1, QE2, QE3 … etc.
Gold and sovereign credit crisis in euroland
Sovereign credit woes in euroland resulting from market concerns about the
public finance crises faced by eurozone member states in the final years of the
first decade of the 21st century negatively impacted market outlook for the
euro and the pound sterling. This development has made the already
much-impaired dollar appear as not the only bad choice as a reliable store of
value.
As a consequence, many investors, affected by Pavlovian conditioned reflex,
sought out gold as an alternative to fiat currencies. This herd behavior trend
is evidenced by large consumer purchase of coins and small bars in retail
markets around the globe. Similarly, the gold exchange traded funds (ETFs)
sector experienced consistently strong inflows of funds all through 2010,
adding in aggregate over 270 tonnes of gold by Q2 to assets under management by
ETFs.
Furthermore, net long positions on gold futures contracts, which are a proxy
for the more speculative end of investment demand, also returned to high levels
close to those seen during Q4 2009. Conventional wisdom suggests that longs on
gold are essentially shorts on fiat currencies even though in reality, the
simplistic correlation does not always hold.
On the other hand, jewelry consumption in the advanced economies was hit by
record high gold prices and by an increase in volatility toward the end of
2010. Retail gold jewelry prices simply could not rise as fast as commodity
gold prices without adversely affecting consumer sales. While retail gold
jewelry merchants saw appreciation in their gold inventories, they were
actually losing money on every gold ring they sold from their inventories if
cost to restock at some future time were taken into account, unless they are
protected by hedges. Yet if retail gold jewelry merchants raised the retail
price of their gold jewelry, they would suffer sharp drops in sale in a
consumer market already hit by a protracted severe recession and would suffer
financial loss from not having enough sale volume to cover fixed overhead cost.
However, gold jewelry demand from emerging markets such as India and the Middle
East remained strong in 2010, relative to falling consumption levels
experienced in 2009 in the advanced economies. Moreover, solid economic growth
at near double-digits in China, the biggest emerging market, has been positive
for gold consumption there.
The price of commodity gold reached new highs not only in dollar terms, but
also in term of all other fiat currencies, especially those in Europe where
government fiscal austerity measures to resolve noxious public finance has
created a gloomy economic outlook and a negative market view on the euro. In
early Q2, 2010, many other fiat currencies not only fell against the benchmark
dollar but also experienced abnormally higher levels of volatility.
Gold prices in different fiat currencies
Consequently, since currencies did not depreciate in lock step, gold prices in
Q2, 2010, rose by 11.5% in US dollar terms and 23.1% in euro terms, while
rising 13.2% in sterling and 14.3% in Swiss francs, reflecting the relative
strength of the currencies.
Both the Canadian and Australian dollars did not fare much better as lower
commodity prices impacted those two natural resource producing economies, with
gold having seen a price increase of 16.6% and 20.9% in those local currency
terms respectively.
At the other end of the spectrum, gold posted its lowest quarterly return of
5.7% in Japan, where the yen appreciated substantially versus a range of other
currencies, including the benchmark dollar. In Q1 2010, both the dollar and the
DJIA out-performed gold, which ended the quarter at $1,115.50 per troy ounce.
Gold bubble
The gold price performed strongly during Q3 2010, ending the quarter at
US$1,307.00 per troy ounce on the London PM fix, compared with $1,244.00
at the end of Q2 2010 and $1,115.50 at the end of Q1 2010. This represented an
increase of 5.1% in the gold price in US dollar terms between Q2 and Q3, in
line with its quarterly average gain over the past five years which, in turn,
reinforces the view held by some that gold's appreciation appears steady and
measured and does not exhibit the same statistical characteristics observed in
previous asset bubbles.
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