Gold and silver remained resilient yesterday (gold slightly lower; silver slightly higher) despite the continual wave of mini tsunamis shaking the global economy. World stock markets continue to reel from the deterioration of the financial system which is spreading to the global economy and the DJIA fell to levels last seen in 1997 and the Nikkei fell to levels last seen 26 years ago in 1983.
The United States vowed to prop up ailing banks such as Citigroup and the giant insurer AIG if needed, but worries that yet more massive bailouts, cash injections and even nationalisation will fail to staunch the global economic crisis are weighing on stock markets around the world and mean that safe haven demand for gold remains robust.
As long as central banks continue to debase their currencies by trying to inflate their way out of this recession through zero interest rate policies and massive money printing and digital money creation, gold will remain in a bull market. This is clearly seen in the charts below in which the correlation between rising interest rates and rising gold prices can be seen. Gold rose by 2,400% from 1971 to 1980. During the same period, the Federal Funds Rate rose from below 4% to over 18%.
Today, interest rates are close to zero and thus there is no opportunity cost to owning the non yielding finite currency that is gold. Indeed there is unprecedented counterparty and systemic risk in keeping one’s savings in a bank. And government bonds look increasingly risky with even the most developed nations sovereign bonds being at risk of being downgraded. Considering they are considering printing money top buy their own bonds it is amazing that they have not been downgraded already.
Only when bond yields and interest rates have risen significantly and systemic risk abated will gold prices stop rising. We are a long way from there yet. As the bubble in bond markets begins to unravel, large sums of capital will flow into the safe haven of gold.
Indeed there are interesting parallels with the mid 1970s. Gold rose from $35/oz to $200/oz or nearly 6 times. Then gold prices fell from $200/oz to $100/oz in 1976 prior to surging by more than 800% – from $100/oz to over $800/oz in the latter part of the 1970’s.
Gold fell from $1,030/oz in March 2008 to a low of just above $700/oz in late 2008. If gold were to repeat the performance of the mid to late 1970s then it could rise to over $5,000/oz ( 8 X $700/oz = $5,600/oz) in the coming years. Thus besides essential safe haven diversification attributes, gold also has significant potential for real and substantial capital gains that could help investors recoup some of the significant losses they have suffered in property and equity markets in recent years.