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Economic Insights

The precious metal is back in the spotlight, but its prospects for price appreciation have dulled. Here's why.

The frequency with which gold comes up in conversation tells a lot about the prevailing levels of fear among investors. Whether concerns center on ill-considered fiscal or monetary policies, currency depreciation, debt default, inflation, or, remarkably, deflation, too, gold presents itself as an investment answer. Its price prospects depend, then, on whether the potential buyer believes consensus will become more afraid than it is or less. At present, there is still plenty to fear, but probabilities favor either a measure of relief or little change rather than more, suggesting that gold's price is more likely to fall further or hover where it is rather than rise.

Certainly this response by gold to the ebb and flow of worries emerges in the historical record. When gold hit its last big high in August 1980, at $627 an ounce (a bit more than $1,500 in today's prices), there was plenty to fear. The economy had slipped into recession again after a disappointing decade, inflation had risen to double-digit rates, the dollar had lost a big chunk of its foreign exchange value, and few had any confidence in the efficiency of either fiscal or monetary policy. But as former Federal Reserve chairman Paul Volcker's policies began to break the back of inflation and pro-growth fiscal policies prompted a secure economic expansion, these fears began to ebb, and gold's price dropped. By 1987, the price touched $400 an ounce, down 36% from the 1980 high. It spiked briefly late that year during the stock market crash, but with recovery in markets and continued economic growth, gold fell into the 1990s, especially as collapse of the Soviet Union relieved long-standing geopolitical concerns. By 1999, the price of gold hit $282 an ounce, down 57% below its highs of 1980.1

Things changed after the attacks of September 11, 2001. Even as the economy emerged from recession and inflation remained well contained, gold prices rose in response to the uncertainties of the new war on terror. The price of an ounce passed $1,000 in 2008, in response in particular to the dollar's accelerating losses on foreign exchange markets and continuing problems in Iraq. The global financial crisis of late 2008–early 2009 intensified fears across a broad front and pushed up further the price of gold. Concerns over the developing crisis in Europe, the subpar economic recovery, and the ultimate inflationary effects of the extraordinary monetary ease used to fight the crisis pushed up prices in 2010 and 2011. That year, as the European crisis intensified and the "Arab Spring" brought new geopolitical concerns on top of everything else, the metal's price rose to $1,900 an ounce, up 90% from 2008 and almost 600% from the lows at the turn of the century.2

Since those 2011 highs, the price has dropped dramatically. This decline has occurred not because concerns have gone away. On the contrary, all remain. But none now look as imposing as they did in 2011. The price of an ounce has fallen recently to about $1,300, down a bit over 30% on balance from the 2011 highs, but still well up from levels that prevailed before the financial crisis of 2008–09. Looking forward, there are persistent worries, but likelihoods suggest that fears will either stay at present levels of intensity or relax further. Here is how the various influences on gold's price look at present and their likelihoods for the future.3

Central banks continue to buy gold, less out of strategic investment interest than as part of a long-term effort to diversify their reserve holdings. Similarly, individuals in South Asia and the Far East continue to buy, less for tactical investment reasons than as a form of ongoing savings. Retail purchases in the United States also persist in response to the hawking on television, Google ads, seemingly everywhere. Though these ongoing sources of demand will likely keep prices above where they otherwise might be, they are insufficient in themselves to drive up prices from current levels. They were, after all, in place even as gold prices fell precipitously after 2011.4

So, too, the decision by the Fed to carry on with its extremely accommodative monetary policy leaves little reason to expect a sudden shift in gold prices. Of course, a continued flood of liquidity into the financial system tends to hold up the price of gold by threatening longer-term inflationary pressures. But this circumstance has prevailed for years now and surely has long been reflected in gold's price. It would seem, then, that a tapering in the flood of Fed-provided liquidity would relieve such inflationary fears and allow the price of gold to fall. But such a move is as likely to raise gold's price over fears about a shock to the economy as it is to drive it down over relief on the inflationary front. That, after all, is what happened when the consensus expected the Fed to taper the extent of quantitative easing. Gold prices actually rose briefly during that time last summer, from $1,250 an ounce to $1,400, only to fall back almost entirely when it became apparent in September that the Fed had decided to delay the policy shift. A steady state for the Fed is then more likely to hold gold prices even than anything else.

Washington will face renewed budget debates in the new year, as legislation to keep the government open expires in January 2014 and the country again will come up against the new debt ceiling in February, the Treasury estimates. Chances are that markets, including the gold market, will react to these coming troubles as they did to this last round, with caution, but with none of the panic promoted by Washington. For all of Washington's angst at the time, market tremors gave no sign of a concentrated rush to the security of gold. To be sure, a firm budget compromise would relieve much fiscal anxiety and push down the price of gold. But a grand bargain is hardly likely. Government will, in all probability, do what it has just done and has done for the last five years—agree to differ and postpone the decision, a pattern that will neither relieve nor intensify investor anxieties and so have slight net effect on gold's price.

Economic likelihoods offer little prospects of a shock either. Were the pace of real growth to accelerate, fears about the economic future would ebb and the price of gold would fall. But this potential is limited, for all the reasons such an acceleration has eluded this recovery so far. Still, the prospect of a relapse into recession, something that surely would raise anxieties and so also the price of gold, is even less likely. Though the pace of growth is disappointingly slow, the economy lacks pre-recessionary signs. Housing is expanding, albeit slowly, and home prices are appreciating. The economy has never gone into recession in the face of a real estate expansion, even a modest one. Corporations are flush with cash. If they remain cautious, the cash tells that they in no way face the financial squeeze that typically leads to cutbacks and recession. Households have improved their finances. With an admittedly slow but nonetheless positive payroll expansion, that financial improvement should allow continued moderate advances in consumer spending.5

If the domestic economic climate looks unlikely to alter gold's pricing equation, prospects in Europe and on the currency front look balanced as well. There is little or no chance that Europe will dramatically reduce gold's price by finding a way out of its fiscal-financial mess anytime soon. Policy change simply is not moving fast enough. But at the same time, little suggests much further deterioration. The European Central Bank (ECB) shows a clear commitment to fighting the most intense strains of the situation, as does Berlin, especially in light of the September elections. If the European situation remains in its current, admittedly subpar, state, so, too, will the dollar-euro exchange rate. For the yen, likelihoods are for modest further dollar appreciation, which by itself would tend to reduce gold's price, though hardly enough to form a new trend. Nor would expected modest dollar depreciation against China's yuan offer enough of a move to change gold-price trends.6

Geopolitics, as ever, remains a wild card. No doubt, direct action by the United States in Syria, even if "incredibly" minor, to steal the secretary of state's eloquence, would put upward pressure on the price of gold by threatening a wider war. To that extent, the current Russian "solution" to dismantle Syria's chemical weapon's stock, dubious as prospects are, has tended to hold prices down. The Iranian nuclear threat remains. An Israeli or U.S. military strike would, of course, greatly intensify fears and cause gold's price to spike upward, perhaps even beyond the old highs. But, impossible as it is to weigh odds on such an event, it is not unreasonable to proceed on the assumption that neither country is ready yet to make such a dramatic move. Short of such action, the Iranian tension has long had a presence in gold's pricing. To the extent that this latest round of negotiations makes progress, gold's price may well fall. If the diplomacy just drifts, as it has to date, it would change little in the pressures on gold's pricing.

The risks of a change in any one of these influences are undeniable. Much is unpredictable, especially since the price of gold hinges on so many considerations these days. But it is still reasonable to conclude from the balance of probabilities that prices will more likely decline or stay stable than increase. Even stability is hardly attractive, since gold pays neither a dividend nor interest.


1 Bloomberg data.
2 Department of Commerce and the Department of Labor.
3 Paul Ausick, "2013 Outlook for Gold and Silver: Risk in Gold, the Devil's Metal Shines," Thinkstock, December 21, 2013.
4 Federal Reserve.
5 Department of Commerce.
6 Milton Ezrati, "The Secret of the Euro's Survival," Economic Insights, October 11, 2013.

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