This should have been the perfect storm for gold. Between October 6th and October 10th, 2008 equity markets worldwide were falling at least by 15%. We were entering a weekend where the G7 and G20 would meet to discuss, how to find a solution to the unwinding financial crisis. There was no certainty at all that there would be a solution. Financial intermediaries on both side of the Atlantic were getting under major stress and the broad public was questioning the overall stability and viability of the financial system going forward. One obvious rational reaction in such a stressful environment should have been to buy the safe haven par excellence: gold.
But on October 10th, the same day where people were queuing in front of gold and coin retailers in London to buy bullion, gold fell from 913 to 850 US dollar an ounce. There are other paradoxes happening on the gold market. On October 27th, the news agency Dow Jones reported that a 24 karat pure one ounce bar of gold had attracted 12 bids, the highest being at 835 US dollar. Meanwhile, an ounce gold was selling at 729 US dollar on the spot market. How come that on the one hand there seems to be quite obviously a huge demand for physical gold, while on the other hand at the same time the gold price is falling?
One explanation might be that while they are obviously a large demand of gold, there might be an even larger supply of it. But why would anyone sell gold in such troubled times? Gold is liquid, i.e. quite easy to sell, but it is of course not a complete equivalent to cash. During a financial crisis, like the one we just experienced, cash is of course short everywhere, when it comes to fulfill some counterparty obligations or margin calls, therefore a large number of market participants need to get rid of their assets and this includes gold. So despite being considered as a “safe” asset, the volatility of gold within the last two months was roughly amounting to two third of the extremely volatile US stock market.
Does this speak against an investment in gold? Not necessarily. Despite its current high volatility, gold might nevertheless give you a good protection of value during those troubled times. Moreover, given the huge debt and money creation of the governments around the globe to mitigate the unfolding global recession, inflation expectations might significantly increase in the longer run. This also pleads in favor of gold. This said gold investors have to be disciplined. Gold has a tendency to create an emotional bonding with the investor, who would say: “it is the safest part of my portfolio; therefore I will never sell it”. This attitude could lead to big underperformances. After having traded above 600 US dollar an ounce in 1980 it took gold twenty six years to reach this level again. Hence a prudent investor buying gold must have a clear price target and also a stop loss and not be apprehensive to sell gold should it break through the stop loss.
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