|
Translation
of the article for the International Precious Metals & Commodities
Show As the crisis surrounding America’s sub prime mortgage market began, not just a minority of market participants were surprised over gold’s strange response to the turmoil: its price did not increase, it decreased. That has since change somewhat; gold’s price did indeed increase over the course of the CDO/MBS/ABS crisis. Nevertheless it is notable that gold has not profited from crisis during the last ten years, on the contrary it has suffered along with stocks. Is gold’s role as a crisis metal over? Is gold now simply one many commodities? What could be the reason for its weak price during crisis periods? To answer these questions we analysed a number of past financial crisis and turbulent market phases. Distinctive price drops in the stock market are good indicators of these types of periods. In order to identify these phases, both automatic and manual methods can be used. Indeed there are mathematical approaches for determining troubled markets, such as a certain percentage fall in prices within a certain period of time or certain changes in volatility. However these approaches have proven unsuitable for our purposes. For that reason manual methods were used to find prominent sell offs. In selecting these occurrences it was essential that the sell offs had happened quickly and were of meaningful magnitude relative to previous price action. This is the sort of price action that is typically identified with investor fear, leaving a strong impression of crisis. Chart 1 shows the Dow Jones Index from August 5, 1993. The lows of twelve weak market phases were selected and marked in the chart.
Why does the observed time period begin on August 5, 1993? That day is an important one in gold’s recent history. It marks the date when systematic intervention aimed at stopping the increase of gold prices began. Central banks store many times the yearly production of gold in their vaults. Portions of that inventory are loaned at marginal interest rates, equivalent to a type of subvention. The cheaply loaned metal ultimately lands on the physical cash market and the additional supply depresses the gold price. Low gold prices are desired because they lead to a stronger dollar, lower interest rates, and increased trust in the financial markets. This subject has been extensively explored recently.* But now back to the twelve prominent price drops on the stock market. Chart 2 is a more detailed analysis of them. It shows a typical stock market correction. Here the lowest price at the end of each respective market correction is used as an anchor in time. The average course of prices of all twelve correction phases is then calculated three months before and after the low. Thus, chart 2 shows the average price of the Dow during the twelve correction phases over a period of six months. You can see that the average price break amounted to a good 10%. It started more than one month before the low. Its high was a about one-and-a-half months prior to the low. You can also see that the break in prices increased notably in speed about two weeks before the low was reached. In addition, chart 2 confirms what the markets have known for a long time, but has been only seldom researched: price breaks typically occur faster than the subsequent recovery, which require more time; arguably the reason is the investor panic that usually accompanies price breaks.
Now how does gold behave during stock market corrections? For that we used the same method as above only with an essential difference: as a time-anchor, the respective low price of the Dow was used and not that of gold. Thus chart 3 shows the average course of gold prices three months before and three months after a prominent low in the stock market. The long line in the middle marks the Dow’s low point. We can discern that gold usually forms an intermediate high about a full week before the Dow’s low. At this point stock prices have already begun falling rapidly. Only then does gold begin to fall, hitting its lows later compared to stock prices. The duration of Gold’s correction also last longer in total. Fundamentally, a connection between financial market crisis and gold prices seems to exists, as has been observed by many market participants. How is this to be interpreted?
For one it is possible that investors who are long gold tend to close their positions in periods of falling stock prices. But that has to be qualified considering the corresponding influences affecting gold’s price, especially those from investors seeking protection in the yellow metal. That is why the second reason can be seen in connection with the historic interest of financial institutions in a low gold price. As previously mentioned, one of those reasons is the shoring up of trust in the finance markets. And there is no better reason for doing that than during a financial crisis. A weak gold price stabilizes the markets. Gold becomes uninteresting as a crisis investment and money flows into the remaining asset classes such as the bond market, or back into the stock market. In addition any impression of a crisis is avoided. Strongly increasing gold prices would suggest larger problems. For these reasons financial institutions desire falling gold prices during difficult market phases.
(*)
For an overview see: CONTACT
INFORMATION
The opinions of FSU contributors do not necessarily reflect those of Financial Sense. |
