By Andrew Geenen, Villanova University
Last week we watched the second largest gold sell-off since 1983, begging the question from the casual investor if the ‘gold bubble’ had popped. The answer is simply NO. While gold prices did fall roughly 10% last week, this drop is likely a market correction for the rapid growth gold enjoyed this past summer. Gold prices have soared in recent months because investors have been looking for a safe haven from the remarkable market volatility and projections of slow economic growth in both the US and Europe. This incredibly rapid and constant price increases in gold has lead investors to believe gold was in a bubble and enjoying cyclical growth fueled by a tumultuous economy. Many see this growth as a ‘flight to safety’ in case sovereign countries in Europe begin to default on their bonds. While these market factors have created an environment for gold’s recent growth, this gold boom can be seen as part of a long-term secular bull market for commodities.
Looking back to 1999, when I believe this commodities bull market began, gold has been up 633.31% while other commodities like wheat, corn, and crude oil have been up 317.50%, 371.22%, and 497.08% respectively over the same time period. Analyzing market history indicates that these long-term bull markets occur over 18 to 20 year cycles. What this means for gold is that if 1999 is when the current bull market for gold began, it should end in roughly 2017-2019 or 5 to 7 years down the road. While the rapid 10% drop in gold prices aroused fears of a massive gold sell-off, dramatic price swings in commodities is relatively commonplace. Commodities tend to be some of the most volatile assets on the market, and the recent drop is indicative of this price volatility. Investors in commodities, particularly in gold, should understand the volatility associated with this asset class and be able to withstand this volatility. Gold is meant to be bought and held as a long-term investment and should not be traded, as the past week has proved.
As for reasons why investors should stick with gold, there are many. First, in this turbulent economy, gold is taking on the properties of currency, with many central banks trying to diversify away from the USD, Euro, or Yen and toward gold. This move is serving to devalue money and drive up the price of gold through inflation but gold’s growth cannot be strictly attributed to inflation. Second, Asian central banks are planning to increase their gold reserves from below 10% to 15% or more said Pierre Lassonde at the London Bullion Market Association’s annual conference. While countries like Italy may end up selling portions of their 2,452 metric tons of gold reserves, this will be out of necessity to stave off default, which I believe will only serve to fuel fears and drive up gold prices. Third, gold prices are based largely on market psychology and with the sovereign debt crisis in Europe and slow growth in the United States, investors will find shelter once again in gold. Fourth, gold tends to be uncorrelated to other asset classes, thus playing an important role in portfolio diversification. This will be important due to how closely linked the US and European economies are, if the sovereign debt crisis ever comes to a head, debt and equity in both regions will take a hit. Fifth, a recent Bloomberg survey of commodities experts projects gold to reach prices of around $2,050 an ounce by the end of the year. The survey also showed that confidence in the world’s biggest gold ETF’s have not waivered, nor have futures traders closed out positions en masse despite the recent down swing. Ultimately my advice is do not panic. Gold will continue to trend upward in the coming months and years just be cognizant if the US dollar begins to rally and equity sees consistent gains, gold prices will then assuredly drop.
