Gold Prices Falling

The assumption among gold bugs was that the flood of new money would cause inflation, making hard assets like gold more attractive. So far, though, there have been few signs of inflation taking root even as central banks in Japan and Europe have begun their own aggressive bond-buying programs.

Well, it is remarkable how rapidly gold prices shot up during a period of irresponsible fiscal policies, with big tax cuts and rampant government spending, denoted by the gray shaded area.

Figure 1: Price of gold bullion in dollars per troy ounce, London market, 10:30am, monthly average. Source: St. Louis Fed FRED.

Well, actually, the graph depicts the price of gold over the 1970M01-2008M12 period. That is, the sample predates the implementation of quantitative easing in the US, the UK and the euro area. The gray shading applies to the 2001M01-2008M12 period. Figure 2 depicts the log price of gold, over the 1970M01-2013M03 sample.

Figure 2: Log price of gold bullion in dollars per troy ounce, London market, 10:30am, monthly average, 1970M01-2013M03. Linear trend estimated over 2001M01-2011M08. Gray shading applies to 2001M01-2008M12. Source: St. Louis Fed FRED, and author’s calculations.

Notice that the slope of the price line is pretty straight over the 2001M01-2011M08 period. Since this is the logged price, this means that trend growth rate is pretty constant, at roughly 17.2%.

Another perspective can be seen by reference to the year-on-year growth rate of gold prices.

Figure 3: 12 month growth rate of the price of gold bullion, in dollars per troy ounce, London market, 10:30am, monthly average, 1970M01-2013M03. Linear trend rate estimated over 2001M01-2011M08 (red line). Dashed lines at QE1, QE2, QE3 start dates. Source: St. Louis Fed FRED, and author’s calculations.

Figure 3 highlights the lack of correlation of various bouts of quantitative easing and acceleration in gold price inflation. This is not surprising to informed observers of recent unconventional monetary policy measures, who are aware that increases in money base have not translated to corresponding increases in money supply (c.f., [1]). On the other hand, some movements are probably ascribable to movements in the policy rate, as Jim describes.

So why the recent drop in prices? One possibility is that expected inflation has declined from previous highs (despite the fact that expected inflation from surveys and from market based indicators have barely budged [2]). Don’t forget predictions of this nature (this one entitled subtly Hyperinflation and Gold: Losing Faith in the Dollar):

… most dangerously, through the mechanism of quantitative easing — buying government debt (Treasury bonds) in order to keep interest rates low and expand liquidity — the Fed inflates Treasury bond prices. If this Treasury debt bubble bursts, the result will be a further rush to commodities in a hyperinflationary attempt to dump dollars.

And you might then see people pushing wheelbarrows of dollar bills through the streets. …

Another (related) possibility is the expected value of the utility of gold in the post-apocalypse world has declined (because the probability ascribed to the collapse of civilization has declined). From the NYT again:

“Gold has had all the reason in the world to be moving higher — but it hasn’t been able to do it,” said Matt Zeman, a metals trader at Kingsview Financial. “The situation has not deteriorated the way that a lot of people thought it could.”

I guess in both of these interpretations, I’m assuming non-rational behavior.

Or it could be a conspiracy.

Real side interpretations focus on the fact that demand for gold has declined as there has been a downward revision in expected income growth in China, a country that has been a support to gold demand in the past.


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