- Markets & Risk Newsletter
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Gold as a Measure of Risk - Is the recent move in gold a sign of economic crisis? How is a precious metal like a singing bird? For many risk analysts, gold is the proverbial canary in the coal mine. Gold prices benefit from safe-haven buying as investors seek shelter from the volatility of the stock market and an uncertain economy. Indeed, on February 20 the price of gold broke above $1,000 for the first time in nearly a year as the Dow Jones industrial average plunged 100 points. But during the following week gold futures softened as traders considered Chairman Ben Bernanke's testimony to the House of Representatives Financial Services Committee, when he presented the Fed's semiannual report on monetary policy and the economy. As a store of value and a hedge against economic uncertainty, gold prices reflect investor confidence, or lack thereof, in relatively volatile securities. There is some basis for asserting that gold inversely tracks the stock market. During the bear market of the late 1970s gold peaked at $840. As the market improved investors sold gold but returned in 1988 and 1990 when stocks stumbled. From a high of $380 an ounce in January 1994 gold began a prolonged decline as investors scrambled to get on the bull market bandwagon that peaked in October 2007 (with a significant setback in 2001-2002). Sure enough, gold prices improved in mid-2001, and then as the market began its slide in November 2007 gold soared, hitting $1,000 by April 2008.
In times of disinflation/deflation the opportunity cost of acquiring gold is relatively low as central banks cut interest rates. Investors in gold do not carry much risk by holding non-interest-bearing gold during low rate environments. Looking forward, if confidence emerges in the stock market as we move into the second quarter of 2009, rising stocks could push gold down significantly. Of course, if the correlation were this simple every gold investor would have the Midas touch. Gold has long been regarded as a cash equivalent, but this relationship is reconsidered when there are concerns about the credit quality of the issuer of the paper currency. The recent breakdown in the strong historical ties between gold prices, euros, and the dollar may reflect the current global financial distress and the assumption of significant financial risk by national governments. Looking forward: Deflation? Inflation? Despite current deflation risks, many investors are concerned that the current pressure on balance sheets will result in currency debasement and significant inflation. If that fear is broad across the major currencies, that would increase the attractiveness of gold as a low-risk investment in a global high-risk environment. Some analysts expect gold to rebound as heightened credit risk, increasing inflation expectations, dismal stock markets, and national monetary and fiscal policies fuel a rally in gold prices. Many anticipate that gold prices will rise to $1,500 an ounce over the next three years.
However, retailers and jewelers are increasingly reluctant to buy at higher levels. India has been the world's biggest importer of gold, and in February 2008 imports stood at 23 tonnes. The figure fell to 1.8 tonnes in January of this year and in February there was no gold imported. High prices have cut demand, and people are selling old jewelry at a profit. When the stock market canary is comatose and the real estate market is built on shifting sand, investors scramble for tangible assets-and gold gains in luster. For information on powerful risk-management tools that will allow you to track and measure the risk of gold and gold-linked instruments, contact PortfolioScience today. |
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