Gold falls when a financial crisis worsens for 2 basic reasons which make total sense when looked at objectively. Resultant government intervention then creates the environment for a future rise in the price of gold. This article explains the causes of the downs and ups in the price of gold and offers suggestions on how and when to act. Words: 868
So conveyed Plan B Economics (www.planbeconomics.com) in their original article*.
Lorimer Wilson, editor of www.FinancialArticleSummariesToday.com (A site for sore eyes and inquisitive minds) and www.munKNEE.com (Your Key to Making Money!) has further edited ([ ]), abridged (…) and reformatted (some sub-titles and bold/italics emphases) the article below for the sake of clarity and brevity to ensure a fast and easy read. The author’s views and conclusions are unaltered and no personal comments have been included to maintain the integrity of the original article. Please note that this paragraph must be included in any article re-posting to avoid copyright infringement.
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The article goes on to say, in part:
Why Does Gold Fall When a Financial Crisis Worsens?
Investors need to understand two things:
- gold is priced in US dollars meaning that as the dollar rises the price of gold falls, all things being equal. The dollar is quickly rising because it is a safe haven (US Treasuries are a safe haven that must be purchased in US dollars) and because asset liquidations around the world are gaining speed causing a growing shortage of dollars.
- gold…is a source of funding for margin calls made on declining assets. This means that gold is undergoing a degree of “forced selling.”
One only has to go back a couple years to see how gold reacts during a financial crisis. The chart below shows the price of gold during the financial crisis…in March 2008…During this time, gold prices fell by about 25% and subsequently recovered all losses. This was a scary ride for anyone holding gold at the time, but it’s an incomplete view of gold’s performance during the crisis.
The second chart below shows gold during the same period priced in US dollars, euros and Canadian dollars (indexed to 100 for comparison purposes). During the 2008/2009 crisis…the US dollar was rising while the euro and Canadian dollar were falling and this is reflected in the different gold prices. Gold priced in Euros and Canadian dollars fell less and recovered faster than gold priced in US dollars. This is precisely because the US dollar was so strong during that period. However, as the monetary response began to unfold (QE1 announced December 2008) and trillions of US dollars were unleashed to backstop the financial system, gold in all currencies began to rally dramatically.
[As I see it, worsening financial crises lead initially to lower gold prices which are followed by some form of government intervention to alleviate the crises and that action, in turn, eventually results in renewed appreciation in the price of gold. As the author of the article puts it] really, the basic steps are straightforward:
- Economic/financial crisis leads to asset liquidation and dollar shortage
- Dollar shortage leads to dollar appreciation and gold depreciation (in dollar terms)
- One form of asset liquidation – forced gold selling – leads to gold depreciation (in all currencies)
- Eventual monetary response creates surplus of dollars
- Surplus of dollars causes dollar depreciation and gold appreciation
Should I Buy, Hold or Sell?
For US investors, in my opinion, a crisis in which a skyrocketing dollar sends gold plummeting in US dollar terms could create a big gold buying opportunity, like it did in 2008.
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[The above] said, the basic steps outlined above could take months to fully materialize. The market is disappointed (read: impatient) with the Fed’s lackluster curve-flattening program (i.e. Operation Twist) because it delays the possibility of additional quantitative easing. However, as the economy continues to deteriorate, the probability of QE3 rises [and] this process could take a long time, and the Fed won’t act until it must act. The Fed simply no longer has the credibility and political support to act boldly and pre-emptively, so it must wait until there’s blood in the streets and politicians are begging for relief.
For non-US investors that own gold, pay attention to the price of gold in your domestic currency because, unless you have hedged, your exposure is relative to your home currency, not US dollars.
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