What’s Behind the Crash in the Gold Market?

Since 2011, the gold market has shown signs of weakness, culminating in a multiday crash that began on Thursday and continued into Monday

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One of the more interesting phenomena to take place in the markets in recent memory has been the seemingly invincible rise in the value of gold. In the decade between 2001 and 2011, the price of gold rose from $256 per oz. to a high of $1,920 — a whopping 650% return for those lucky enough to have timed the trade perfectly.

But since 2011, the gold market has shown signs of weakness, culminating in a multiday crash that began on Thursday and continued into Monday. According to the Wall Street Journal:

Gold futures for April delivery fell $140.40, or 9.4%, Monday to a two-year low at $1,360.60 an ounce on the Comex division of the New York Mercantile Exchange. That extended their bear-market descent of more than 20% from their 2011 all-time high. Since Thursday, gold prices have declined by more than $203 an ounce, a record skid since the futures began trading in the U.S. in 1974.

So what’s behind the remarkable rise in the value of gold — and what changed in recent days that has undermined investor confidence in it?

(MORE: The Real Significance of the Bitcoin Boom (and Bust))

The first thing gold skeptics like Warren Buffett will remind you about the precious metal is that it doesn’t have nearly the utility of other commodities like oil or copper. Sure, we use it for jewelry or dental fillings, but mostly we just let it sit there. In 1998, Buffett famously quipped: “Gold gets dug out of the ground in Africa, or someplace. Then we melt it down, dig another hole, bury it again and pay people to stand around guarding it. It has no utility. Anyone watching from Mars would be scratching their head.” It’s true: unlike stocks, gold doesn’t pay a dividend. And unlike oil, it isn’t a vital commodity that powers other parts of the economy.

Though Buffett may be justified in personally shying away from investing in the shiny metal, in other respects he underplays its significance. Gold has held an enduring place in human history, and a central role in international monetary policy from the early 19th century until 1971. The so-called gold standard — a system in which national currencies were ultimately redeemable for a fixed amount of gold — was the law of the land in much of the world until 1971, when Richard Nixon formally severed the convertibility of the dollar. Since that time, governments across the world have been in the peculiar position of having their currency backed by nothing more than faith. For instance, under this system, the U.S. could theoretically print and spend money endlessly, with no fear that its spending of dollars would deplete its stock of gold.

Since 1971, this era of “floating” currencies has been a contributing factor in developed countries’ ability to take on more and more debt, a dynamic that has reached new highs since the financial crisis. The rise of gold in recent years can be explained in part by investors’ understandable lack of confidence in governments’ ability to keep their debt under control, and therefore the value of their currencies high. In fact, central banks across the world in recent years have also diversified their holdings into gold as a hedge against a decline in the value of the dollar.

(MORE: The Right — and Wrong — Ways to Buy Gold)

In addition, it has become much easier for the average investor to invest in gold through exchange-traded gold funds or derivatives.

All of these factors have contributed to gold’s rise, but what about its recent crash? It’s impossible to pinpoint the exact cause of any market correction, and analysts have floated a range of possible reasons, from the Cypriot central bank’s need to sell off some its gold reserves to pay for its bailout to recent data showing weakness in the Chinese economy. But nobody knows for sure why gold is declining in value because it’s nearly impossible to pinpoint gold’s fundamental value. Most assets are valued at the sum of the future income they produce, but of course gold produces no income. It has no inherent value beyond the fact that humans have always valued it.

Gold is often spoken of as a hedge against inflation, but really gold is a hedge against catastrophe. Compact and convenient to transport, it’s the one commodity that you can expect to be valuable no matter the political situation. In other words, gold is a great bet if you think there’s going to be a revolution.

Any student of history knows that change, often violent change, is the one constant that can be relied on. Gold enthusiasts are absolutely right to question whether our current monetary regime of floating currencies — now in its fourth decade — will last. After all, the post–WW II Bretton Woods monetary regime, which came to an end when the U.S. abandoned the gold standard, lasted less than 30 years. And the classic gold-standard era (1871–1913) lasted roughly as long as our current monetary regime. History tells us that change is gonna come; the hard part is figuring out what the change will look like.

Which brings us to the wisdom of investing in gold. While gold enthusiasts may be right to question the sustainability of the dollar’s role as the world’s currency, or government’s ability to keep spending at appropriate levels, that doesn’t necessarily mean that gold is a can’t-miss investment. After all, the most likely result of government overspending is inflation, and even high inflation like we experienced in the 1970s won’t necessarily lead to the collapse of governments or our current monetary order. And if it’s just inflation you are worried about, many assets hedge against inflation — assets that are otherwise safer and easier to value than gold.

As I said before, it’s impossible to pinpoint the exact cause of any market correction, but the severity of the dip in gold is most likely a product of gold’s ill-defined value. If you’re holding gold because of a warranted-but-vague lack of confidence in government’s ability to keep a lid on inflation, I can understand why a slight dip in its value would send you running for the exits. It would make sense to get out of gold and into an inflation hedge that is less speculative.

But let’s not mistake yesterday’s decline for the end of the gold bull run. As the recent brouhaha over the virtual currency Bitcoin has shown, the issues confronting traditional currency have not been resolved. And, unlikely as it may be, the world’s oldest currency may have yet another role to play in the ongoing history of money.

19 comments
jaygo
jaygo

Wonder if this is tied to the Boston incident somehow? Anyone?

AlvaroSevilla
AlvaroSevilla

Behind the fall of the gold market who is? It's easy, the usual manipulators of raw material prices, which using funds in tax havens and not paying tax. It is the stark and soulless capitalism. The perverse pursuit of short-term gain is none other than the destruction of capitalism.
Detras de la caida del mercado del oro quien esta? Es facil, los usuales manipuladores de los precios de las materias primas, los que usando fondos dentro de los paraisos fiscales y no pagando impuesto alguno. Es el capitalismo descarnado y sin alma. La perversa busqueda de la ganancia a corto plazo es ni mas ni menos la destruccion del capitalismo.

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KateLuc63749974

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richard_smith
richard_smith

Want to know what happened regarding the sharp drop in gold? Ther are several good articles on coininfo.com regarding

the manipulative drop in price.  

mary.waterton
mary.waterton

Maybe we are looking at this thing from the wrong perspective. Maybe it's not the value of gold that "crashed", but the currency into which you must convert it in order to buy things. Gold is the only true money because it cannot be fabricated out of thin air. Hence, by definition, it holds its value.

Paper money, on the other hand, can be fabricated out of thin air in unlimited quantity. With all the paper money being printed around the world and loaned to God knows who and for God knows what, I would more strongly suspect volatility in the fiat currencies than I would the value of gold.

ShawnDisney
ShawnDisney

How come no mention of "Paper /Gold" as a way of manipulating the "Gold" market? It is certainly remarkable how Gold shot up like a rocket for 20years,  then mysteriously went flat for the last year or so, when during the same time frame , NO significant reforms were made in the economic scene.

Galen
Galen

Go get `em Libertarians. Hopefully this curshs many of Becks idiots!!

castor
castor

Shut the hell up. I thank you Castor Chua ESQ

tom.litton
tom.litton

@mary.waterton That would assume a simultaneous rise in price of everything else of the same amount relative to gold.  

I suppose you could view it that way.  I don't see the practical difference though. 

Galen
Galen

@famulla5 

The problem with you religionists is, you buy into satan and martyr him more then some god. If it was truly a god of holiness and forgiveness, no satan would be needed.

Your emotional outbusts of capitalizations and threats of death to others, speaks to the point, emotionally, you are already dead and are a victim of this satan you so worship!

Galen
Galen

@famulla5 

But you are the saving grace of a god given satan!

You are a fundamental baffoon, and why many turn to secularism for some sanity from your ilk.

The issue IS, the violence of your mind!

Galen
Galen

@famulla5 

You of twisted perceptions and mental illness. A.Mulla of desperation of mental stability.

Galen
Galen

@famulla5 

Just like you cannot live without the satan phenomena if ignorance.

Galen
Galen

@famulla5 

Nothing sounds nutty coming from you... haaaaaaaaaaaaaaaaaaaaa!

Galen
Galen

@famulla5 

Hey Franko......... we need you to pick our government representatives, that way we could have substance. Who does not get it !?