I wrote a blog two years ago titled The Gold Bubble, where I commented that gold was not an investment, but a price speculation. Gold had just risen above $1,500 per ounce and many people believed $2,000 an ounce would be reached shortly. Gold did reach a high of $1,896 per ounce on September 5, 2011. Now that the largest one day price drop in the past 30 years occurred in April, taking gold down to $1,360 per ounce, I thought it was time to follow up.
Investors often buy gold thinking it is a hedge against inflation or a safe haven during times of uncertainty. Concerns about inflation have been common, citing the Federal Reserve’s policy of easy money and the drop in value of the US dollar against other currencies. There has also been a lot of uncertainty as our country has been running record budget deficits and Congress and the President have been at odds over how to reduce them. The great panic of 2008 kept investors out of the stock market. Yet despite these problems, gold has fallen, while the stock market has pressed on to reach a new high. This prompted a friend to comment recently that there must be a disconnection between the stock market and reality.
Some investors forget stocks represent ownership of companies. Companies are constantly looking for ways to improve themselves. They develop new products and services, search for ways to make their current products more affordably, and look for ways to reduce costs and maintain profitability. Not all companies improve, but when they do their stock price often increases. Gold does none of these things. The price moves with supply and demand. The great panic helped build a huge fear premium pushing the price of gold higher. The fear premium appears to be fading and so the price has been falling. As I wrote two years ago, it didn’t take much of a drop in demand for the price of gold to reverse direction.