In Times of Uncertainty Are Gold Prices Certain

28 March 2011, 1:34 p.m.
By Daniela Cambone
Of Kitco News
KITCO

Editor's note: Gold during Catastrophes – Kitco News Asks: Is there is a Link? Does Gold automatically soar during natural catastrophes? Wars? We asked a panel of experts to chime in and remember past historical events when they were surprised by gold's performance.

(Kitco News) - With the recent earthquake in Japan and the civil war in Libya, many investors expected gold to soar easily to $1,500. Experts said, however, that gold does not necessarily rise during wars or crises; it all depends on a series of factors including the economic context of the time.

"The generalization is, there is no generalization. When there is a catastrophe – people sell everything," said Mark Leibovit, a chief market strategist for VRTrader.com. "I'm not banking on the disasters. When bad news hits, I'm afraid everything will drop," he told Kitco News.

In a March 15 report, HSBC said, "Historically, estimates of drops in commodity demand due to natural disasters or other economy tend to be exaggerated. This was the case with previous earthquakes in Japan, attacks in the US on September 11, 2001, and the 2004 tsunami in the Indian Ocean."

The yellow metal has become a new currency but that doesn't prevent it from dropping when there is a disaster said Leibovit. "Basically since 2001 if you look at the stock market and gold they more or less track each other – which is sort of interesting you'd think it would go the other way," he said.

Leibovit was surprised by gold's performance during the crisis of October 1987 when stock markets around the world crashed. "Gold really didn't do that well – it had an initial pop but it really didn't provide the hedge…I wish I could tell you categorically that gold is a hedge," he said.

The price of gold was pegged in London at $465.50 on Friday, Oct 16, explained technical analyst, Peter DeGraaf.

"When the stock market dropped precipitously on (Black) Monday October 19, gold initially rose to $481.00, as investors sold stocks and searched for a 'safe haven.' Surprisingly, the following day the price fell back to $464.30, as the need for cash became greater than the demand for a 'safe haven.' When things settled down gold slowly rose, to end the year at $484.00," said DeGraaf.

The conclusion drawn from gold's reaction to the market crash in 1987 is that the price of gold in the long term is dependent upon the integrity of the currencies that represent gold, rather than upon the political and economic events that dominate the news of the day, said DeGraaf.

George Gero, Senior Vice President-Financial Consultant for RBC Wealth Management said it all depends on the type of crisis. Gero reflects back on the Iraqi war. "The next day after the shock and awe bombing, oil dropped $40 bucks, and so did gold," he said.

He cited last summer's debt crisis in Greece as another example, noting that gold dropped $50 dollars that day. "Everybody thought that the ECB and Greece were going to sell gold to finance the bailout which didn't happen. So the behavior of gold during a crisis depends on the type of crisis and whether gold is needed for liquidity purposes to finance war or a bailout," he said.

Gero also looked back to the assassination of Egyptian president Anwar Sadat in 1981. "The media kept telling the world there was no assassination until the next afternoon. Gold acted totally contrary to what everyone thought because of the withholding of the actual assassination news. "

So in the wake of the Libyan civil war and Japanese earthquake, why has gold not moved upwards? Gero replied, "The ultimate safe haven has turned out to be the liquidity and the safety of the United States and Canada." He said that gold has been so well publicized and so well-owned that people are now looking at silver as having more volatility left than gold.

Jeff Christian, Managing Director of New-York based commodities research firm, CPM Group said, "We have always been kind of snotty about this – what we said is that those political events that are important to gold are important to gold, and those that are not are not."

For Christian, a pivotal event occurred during the Iran-Iraq war in 1987 when Iraq attacked a Kuwaiti oil tanker near Bahrain. The Kuwaiti government eventually went to the US government asking for protection of their oil tankers, said Christian. The US ultimately established a massive military presence in the Persian Gulf and most, himself included, expected this to be bullish for gold, said Christian. To the surprise of most, the price of gold fell.

"We called some of our clients in the Persian Gulf, in Kuwait and said, 'why aren't you guys buying gold?' And they said, 'our problem is solved… from our perspective the US navy sailing into Persian Gulf, represents a massive reduction in political and military risk,'" he said.

Christian also referred to 1982 when Argentina invaded the Falkland Islands. This precipitated the two-month-long undeclared Falklands War between Argentina and the United Kingdom and resulted in the defeat and withdrawal of the Argentine forces.

"There were people in the gold market who said, 'why is gold not responding to this?' and we said, 'because it is Argentina over Britain in the South Atlantic in the Falkland islands which do not produce gold,'" he said.

Christian said that Chile could go to war with Peru again and it probably wouldn't really affect the price of gold because it is not central to the gold market. "If something happened in a place like Pakistan versus India – where you have two people who are very much gold and silver oriented then you probably would see a reaction."

Frank Holmes, CEO of U.S. Global Investors, said gold will go up if there is a prolonged war regardless of the country. "If it is under siege for a long time that country's currency gets destroyed, so gold in that country's currency will take off," he said.

The country must raise money through taxes or issued bonds to fund the conflict, he said. "A quick, slam bam, thank you M'am – is not really a sustainable reason for gold to rally," he said.

Like Christian, Holmes was also expecting gold to spike during Operation Desert Storm. "That was a factor that surprised me and that is when I started doing a lot of research and looking at that fear trade," said Holmes.

The "fear trade" according to Holmes, is driven by negative real interest rates-where inflation is greater than the nominal interest rate-and deficit spending. Whenever you have negative real interest rates coupled with increased deficit spending, gold tends to rise in that country's currency, he said.

When examining the recent earthquake in Japan, Holmes said the impact on gold may not be felt short-term but long-term it could be bullish. The $500 billion needed to be spent in Japan will inevitably be good news for gold, said Holmes. "We are going to see some unique social spending on housing which will put big demand on all commodities," he said.

By Daniela Cambone of Kitco News; dcambone@kitco.com

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