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All that glitters is sometimes actually just gold

Published on 14th Mar, Edition 11, 2016

 

Gold prices spiked up and peaked at $ 1,900 per ounce in 2011 primarily as a result of the anxiety of anticipated runaway inflation following the massive QE (Quantitative Easing) program unleashed primarily by the Federal Reserve Bank of the US as well as other Central Bankers. This was the zenith of a bull run that started 10 years earlier and capped a mouth-watering return of almost 650% over the decade.

With inflation not making an appearance and with excess liquidity and low interest rates sparking a bull market across equity, real estate and raw material prices, gold fell out of favor and bottomed out towards the end of 2015 at a price of $ 1,050 per ounce. We have since seen prices increase by an impressive 21% till recent close (about $ 1,270) and there are again a lot of headlines about gold outperforming a number of asset classes. The rise in gold and in February primarily, had been in tandem with a sell off in the equity markets. What has been remarkable is that this has happened in an environment of an increase in US interest rates (gold fundamentally moves inversely to changes in interest rates) and while the US stocks market recovered over the course of the last few weeks, we have not witnessed a sell off in prices during this resumption of ‘risk on’ trades.

Gold was used as a means of exchange or currency since 600 BC. It has been a store of value, a traditional hedge against inflation, a safe haven or refuge at times of political and economic upheaval as well as a prominent feature in successful wedding negotiations in the Sub-Continent. With the crash of 1929, gold was used as a means to safeguard wealth and there was such a run to hoard the commodity that Roosevelt started regulating the holding and exchange of gold and with this followed the end of the gold standard — the means by which foreign exchange was priced. This marked the birth of the foreign exchange trader and with this, a new means of economic warfare.

 

Free market dynamics have been the pride of the US financial model and many others that followed suit but it has been very much the unabated growth in ‘free markets’ that have led to many markets being anything except ‘free’. The most poignant example of this was an interview with Mervyn King while as head of the Bank of England described how he implemented the QE in the UK financial markets. He mentions how he opened up the computer systems at the BoE and simply created wealth by typing in numbers into their balance sheet.

The volume of gold traded on a daily basis far exceeds proven physical reserves and there is an old saying that you couldn’t fill two Olympic size swimming pools with the amount of physical gold that actually exists in the world. While this is true of many of the commodities that are traded on the physical and futures exchanges, it is difficult to imagine people wanting to take physical delivery of copper or crude oil barrels as a store of wealth. Our financial systems are currently over indebted and any more shocks to the system could well see demand for physical gold hit unprecedented levels, which considering the lack of availability of physical could see prices hit new highs……very high highs.

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