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Reasons for the Fearful to Be Fearful of Gold

Matthew A. Winkler is a Bloomberg View columnist. He is the editor-in-chief emeritus of Bloomberg News.
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Have Gold Prices Found a Floor?

The stock market's dreadful January coincides with a chorus of predictions that the fall of gold has reached bottom from its lofty peak in 2011. Gold is the investment of the fearful, and there's fear of just about everything from recession to terrorism. Indeed, gold rallied 6.3 percent during the past six weeks.

On casual inspection, it's easy to conclude that the price of gold has nowhere to go but up after a four-year slide to $1,045 an ounce in December from a record $1,923 -- a 46 percent decline measured by futures contracts.

The Rise and Fall of Gold

Look harder. Gold has fallen much faster and a lot further before. Between January 1980 and June 1982, for example, the precious metal lost 66 percent of its value, dropping to $298 from $873.

Ups and Downs

Source: Bloomberg

That made sense. The gold price had been driven up by fearsome inflation, which soared to 14.8 percent before receding to 2.5 percent by July, 1983. The yield on the 10-year Treasury note, a reflection of the Federal Reserve's determination to shore up financial assets, reached 16 percent. As these rates fell back to earth, so did gold. Inflation today is barely visible at 0.7 percent.

Gold Meets Inflation

Source: Bloomberg

November 1981 marked the beginning of a rapid expansion of globalization, coordinated monetary authorities and robust bull markets in bonds and stocks. During the last two decades of the 20th century, the returns on these investments were overwhelming -- the Standard & Poor's 500 Index appreciated 1,099 percent while U.S. Treasury bonds reaped an average 432 percent from income and price gains.

They proved just as hardy in the 21st, when the S&P 500 and Treasuries climbed 76 percent and 126 percent. That was despite unprecedented speculation in residential and commercial real estate, the ensuing economic crisis and worst recession since the Great Depression that ushered in gold's rebound until governments and monetary authorities restored confidence. 

While gold rallied for several years into the housing bust and financial crisis, it failed to match the returns of stocks or bonds in the subsequent expansion.

Now China's slowdown has stoked enough anxiety to burnish gold's appeal. Among 24 traders and analysts surveyed by Bloomberg News, 17 are bullish on gold. A handful of global investors predict the end of U.S. growth and a stock market crash similar to the 2008 disaster. The world's largest gold exchange traded fund, SPDR Gold Shares, saw a 3.8 percent inflow increase during the past four weeks after $2 billion of outflows in 2015, or 7.6 percent of its total market capitalization.

Amid the current gloom, though, financial assets show no signs of losing their advantage. That's because they are underpinned by an economy that shows none of the weaknesses that prompted the last recession or any of the preceding ones.

Leverage in credit is a mere shadow of what it was seven years ago. Corporate debt ratios among the biggest and smallest companies in the Russell 3000 are now near 30-year lows. U.S. homes are at their highest valuations since October 2007, while house prices climbed for 10 consecutive months, the longest streak since 2006. At the same time, the supply of houses remains near an all-time low, according to data compiled by Bloomberg. The belated recovery of U.S. homeowners means they are feeling more confident.

Meanwhile the rest of the U.S. economy is on the verge of full employment, which helps explain why the Federal Reserve decided last month to raise interest rates for the first time since 2006. The Fed's relationship with global investors is stronger than at any point in the past three decades as measured by the stability of financial assets. In the $13 trillion market for U.S. government debt, the average volatility of U.S. Treasury bonds has fallen 25 percent since Janet Yellen took the chair from Ben Bernanke at the Fed, and is 69 percent of what it was under Alan Greenspan, according to data compiled by Bloomberg.

Not So Volatile

Source: Bloomberg

For gold enthusiasts, these aren't encouraging signs. The price of gold and the yield on the benchmark 10-year Treasury bond have consistently moved in opposite directions since 2005 and the trend is accelerating, according to data compiled by Bloomberg. That's the surest indication of the gold market cowering before the Treasury market and bowing to the authority of the central bank when it comes to fighting inflation.

Unless the Fed reverses its stated policy of tightening credit gradually over the next two years, interest rates are likely to climb. According to 68 analysts surveyed by Bloomberg, the 10-year yield can be expected to increase to 2.5 percent from 2.1 percent by the end of the second quarter, to 2.7 percent by the end of the year and 2.8 percent in 2017.

If history is any guide, the recent flow of funds into gold won't mean much in the long term. While there were two consecutive months early last year when the SPDR Gold Shares ETF attracted more than 4 percent of its market cap in new money and a similar trend in 2012, these inflows were just blips followed by larger outflows, according to Bloomberg data. 

Which brings to mind the proverb that has made gold a problematic investment for the past three decades: Fools rush in where angels fear to tread.

(With assistance from Shin Pei)

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

To contact the author of this story:
Matthew Winkler at mwinkler@bloomberg.net

To contact the editor responsible for this story:
Jonathan Landman at jlandman4@bloomberg.net