Gold Explodes, Then Implodes – Again

GOLD EXPLODES, THEN IMPLODES

It shouldn’t be a surprise to anyone, because it has happened before.

Gold’s quick roundtrip from $1540 to $1610 and back again ($1539 earlier today) had its roots in actions and words between the United States and Iran. Prognosticators say there is more to come. Maybe; maybe not. But there is historical precedent for gold’s action.

“In late 1990, there was a good deal of speculation regarding the potential effects on gold of the impending Gulf War. There were some spurts upward in price and the anxiety increased as the target date for ‘action’ grew near. Almost simultaneously with the onset of bombing by US forces, gold backed off sharply, giving up its formerly accumulated price gains and actually moving lower.” ….Gold And Unrealistic Expectations

More recently, during 2018, the backdrop of world events was similar but the results for gold prices were different. News headlines and stories about North Korea seemed to indicate that a horrific confrontation was inevitable. The threat was real, and any fears were justified.

However, expectations for higher gold prices as a result of a potential war failed to materialize. The safe haven characteristics often attributed to gold did nothing to keep it from declining nearly two hundred dollars per ounce between January and August of that year.

IS GOLD A SAFE HAVEN HEDGE?

Before answering that question, let’s return our attention to the Gulf War 1990-91. Referring to gold’s quick drop in price “almost simultaneously with the onset of bombing by US forces”, gold observers seemed somewhat surprised. Quick and decisive action by US forces –  and the positive results – were cited; but is that all there is to it?

While the explanation is convenient, it is unsatisfactory. What mattered most for gold prices was not the impact of the war on gold itself. It was the impact of the war on the value of the US dollar. The quick resolution was supposedly less costly and more efficient, thus less damaging to the status of the dollar. Even a prolonged involvement would not likely have undermined the relative strength of the US dollar.

However, if the results were not as positive, as quickly, and the scale of war had escalated such that hugely disproportionate funds were spent much more rapidly and longer-term, then it is more likely that the reality of negative impact on the strength of the US dollar would be felt and actualized.

Primarily, the negative impact is the result of inflation that is created by the government. Government expands the supply of money and credit more than it might ordinarily do so in order to finance the war.  Thus, the effects of the inflation are not so muted.

Depending on how pronounced the effects, (i.e., how much value does the US dollar lose?) then it is reasonable for them to show up in higher prices for gold.

Still, whether higher prices for gold materialize or not, and to what extent, are matters of subjectivity. To what extent gold prices reflect the amount of inflation that has been created is not a predictable equation.

The price of gold is a reflection of the corresponding weakness (or relative strength) of the US dollar. The changing price of gold, in the market place, reflects changes in value of the US dollar.

Gold is not subject to  changes as a result of war and rumors of war. Nor is it affected by political instability, civil unrest, or assassinations. Therefore, it is not a safe haven hedge.

A higher gold price is directly related to a loss in purchasing power of the US dollar.