May 26th, 2010

Why Gold Prices Aren’t Rising

There’s much conversation these days about how commodity and precious metals prices have stalled or even declined (as represented by their respective ETFs) with the slow down in the worldwide economy and volatility in international currencies and financial markets frequently being given as the explanation.

At times like these, wealth’s tendency is to reduce risk (i.e., sell assets) and seek safety. Since the locus of today’s uncertainty is the EU, one such safe-havens appears to be the $US, causing it to appreciate 16.28% against a basket of foreign currencies since December 1.

Gold has been another traditional safe-haven throughout history. And yet, due to our usual provincial view of the world, Americans question gold’s traditional role because its price has increased only marginally, to 118.47 for the gold ETF today vs. 117.37 at the close on December 1, 2009. With all the turmoil in Europe and its Euro, why hasn’t gold appreciated if it’s such a safe-haven.

It depends on which currency of the foreign exchange prism you viewed the price of gold. If you lived in Paris or Geneva or Sydney, you probably wouldn’t be asking the question. For example, the price of gold in Euros has appreciated 25.5% since December 1. Gold’s price has also appreciated for those who look at it in terms of Swiss Francs, UK Pounds, Australian Dollars and Japanese Yen (click on image to enlarge):

Because gold is a store of wealth, it’s price fluctuates both in terms of it’s underlying supply/demand relationship and in terms of the exchange value of the specific currency into which you want to convert it, something that’s also true for other commodities like oil, copper or silver.

Gold appears to us to not have appreciated because the $US has increased in value relative to other currencies so much in such short a time. In retrospect, those in Europe who were looking to dispose of their Euros could have been essentially indifferent between converting them into either $US or gold since their prices (in terms of Euros) have moved essentially in tandem. What does it mean for us in the US? So long as the $US is considered as much a safe-haven as the precious metal, it could be difficult to look for gold to appreciate much. But how safe a haven is the US actually?

Again, in our provincialism, we criticize the sovereign debt crises of Greece, Spain and other European countries and recommend courses of action they need to take to fix their problems but don’t look in our own backyards to see the mess we’re in. The US debt represents 24% of the world’s sovereign debt (followed by the U.K. with 16%) and yet only around 2.59% of our debt is back up by of gold ranking us 54th among all countries (while the U.K. ranks 92nd with less than 0.15% of their debt being backed up by gold).

How long before the focus shifts from the Euro as a week currency to the Pound and then the $US? Perhaps the traditional June 30 fiscal year-end for Federal, state and local governments and the debates that will ensue regarding deficits, budget cutting, and defaults will be the trigger sending foreign money to again flee for safety, joined this time by Americans, causing the $US to decline and gold and other commodities to increase.

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  • Anonymous

    That's interesting. Do you subscribe to the idea of 'waves'? Gary talks about them – ABCD waves. I personally feel that we're in a B wave (going down). (If that's the case, today would be a good day to buy ZSL.)

  • Dirk

    Just thought I'd leave this message for those holding GLD in a taxable account in the U.S.

    The IRS treats gold, and the etf "GLD" as a collectible not an investment like a stock. You will be taxed at the ordinary rate regardless of the holding period. After year end you will receive a K-1 that you will have to pay taxes on.

    Maybe you knew this but some may not so if you have the option buy your GLD in a tax deferred account like an IRA.

    This is also true for some other etf's like USO which will also send you a K-1 filing. I don't know if the USO (for trading oil) is considered a "collectable" or not but here's what happened to me a few years ago. I baught USO as a trade 3 times in a tax year, the longest holding period on any of the 3 trades was 2 days.

    I made a profit on all three trades, say up $2500.00 for all three, after year end I recieved a K-1 showing a loss of about $1000.00 and my brokerage Co. 1099 type tax report showing my actual gain. When I asked my accountant what's up I found out that the USO was a trust and although I made a profit I could also take the K-1 loss. He warned me then that it could have easily gone the other way, where I would have lost on my trades but received a K-1 with a gain, possibly a big one.

    Since then I've researched my etf selection better and avoid any trust type or "collectable IRS treated" etf unless I can buy it in a tax deferred account.

    Hope this may help some of you.