For the last 5 or 6 years, gold has gotten a lot of attention and many people have gotten on the “buy gold” band wagon. But recently gold investors have gotten smacked around a little. If you are one of those people you’re probably asking what will gold prices do next?
It’s a fair question and it’s too bad that nobody can actually answer it with certainty. But even though nobody knows what’s going to happen for sure, it does make sense to consider some of the fundamentals to try to get a sense of where gold might be headed.
Take a look at the chart below. It depicts what’s happened to the price of the gold ETF GLD compared to the broader S&P 500 over the last 12 months. Buying the ETF is only one way to buy gold but it’s a good proxy to see what’s going on. As you can see, it hasn’t been a very pretty ride. In fact, gold is off about 15% for the year compared to a rise in the S&P 500 of roughly 10%. According to my math, that’s a 25% difference. El Stinko.
What’s behind the drop in gold prices and will it continue?
Again, I can’t answer this with certainty but I’m not hugely optimistic about the potential for gold in the near-term. There are a few reasons for this:
1. Artificial Run Up
It’s very easy to own gold nowadays. More and more people are only too happy to help you do so. In fact gold dealers spend a ton of money encouraging you to trade in a lot of your cash in exchange for a little bit of this yellow treasure.
Mutual fund companies offer up gold ownership by way of ETFs and mutual funds. Radio and TV stations bombard us with offers from all kinds of characters offering to sell us gold coins, bullion, Elvis statutes and the like. With more people rushing in buying up gold in various ways, is it any wonder that the price shot up like fireworks on July 4th?
As you can see from the graph below, gold prices really took off when stocks got flushed down the toilet in 2008. Investors searched for a “safe haven” to put their money because they were traumatized and financially devastated by the market. Those bad market vibes stayed with investors for a very long time and helped fuel the gold run up. That supported gold sellers and provided them with more opportunity to push gold on anyone who could fog a mirror.
And during that same time period, investors were worried about inflation big time. This was a result of the government’s long-standing policy of spending far more money than it took in. So if you try to recall the mindset 5 or 6 years ago it’s easy to see why everyone rushed into gold. The market thrashed investors upside the head, interest rates on bonds were almost non-existent and real estate prices…well…we all know what happened to real estate in 2008 and beyond. Gold was just about the only investment that wasn’t tanking so almost everyone piled on.
So much for history.
Why did gold tank recently?
According to the IBD, gold fell off a cliff because of Cyprus. The theory is that the Cyprus government will have to sell a big chunk of its gold reserves in order to pay its bills. That brings more gold on the market and that in turn depresses prices.
On top of that, inflation (the main reason people started buying gold several years ago) hasn’t yet surfaced in a meaningful way.
I’m not saying that we are out of the inflation infested woods – we’re not. But right now the economy is far from overheated. In fact, we are experiencing one of the most catatonic “recoveries” ever. That means there isn’t much price pushing and that means inflation isn’t a real problem right now. What this boils down to is that one of the main reasons behind gold’s meteoric rise is yet to manifest itself.
And the other force that is probably weighing on gold right now is that more and more investors are becoming more comfortable with risk. Slowly but surely, investors are dumping fixed income and opting for equities. Investors are finally wiping away the emotional fog and realizing that equities have been the place to be ever since 2009. That’s impacting even gold investors who are slowing selling their yellow metal stash and buying equities.
As I said at the start of this post, nobody knows what is going to happen to the price of gold. But the forces that are hurting its price might just be around for a while. Gold was, is and always will be a speculative investment. I have never thought it was a good fit for anyone who wasn’t willing to take risk and speculate. Truth be told, I have never been a fan of investing in gold. I stayed away from gold while it had a terrific run up. Some people would say that I was wrong about gold. Maybe I’m wrong again. Who knows?
Are you buying or selling gold right now? Why?
Neal Frankle is a Certified Financial Planner with more than 25 years of experience, author of the Wealth Pilgrim blog, and a featured contributor here on the “CIF Blog”!