Why is gold losing its shine?
Written by Carl Turner on August 17, 2015.
Gold is a finite resource and as such has been used as a store of value, particularly in times of crisis, for thousands of years, including by the Romans, the ancient Greeks and the Egyptians. Gold still works as a kind of insurance policy even today, which is one reason why gold was strong in the wake of the global financial crisis as investors turned away from equities seeking to shelter their money in less volatile investments.
However since peaking in August 2011, the price of bullion has nosedived. Currently it is worth more than 40% less than its value four years ago.
There are a number of factors which have contributed to gold’s spectacular fall from grace.
1. Interest rates
In the wake of the global financial crisis of 2007, the US Federal Reserve took drastic steps to stabilise the economy, slashing interest rates to stimulate spending. With interest rates low, investors turned towards commodities, and particularly gold, which although it does not generate any return, is considered to be a safe place to keep money and ride out an economic downturn.
As the US economy continues its slow climb back to health, it looks like interest rates may finally start to rise. The rate has languished at 0.25% since 2008 but the chairman of the Federal Reserve, Janet Yellen, indicated to Congress that rates will more than likely rise later this year. Often, where the US goes, the UK follows and Bank of England governor, Mark Carney, has also hinted at possible rate rises in the UK in the New Year.
That is good news for those with cash in the bank but less so for gold which will lose out as investors seek the higher returns that will be on offer from other asset classes.
2. The strength of the US dollar
The dollar is on the up, gaining strength against other currencies around the world. According to the US dollar index, the currency’s value has risen by over 20% in the last year. The value of the dollar generally moves in the opposite direction to the price of commodities because gold is generally traded in dollars so a strong dollar diminishes buying power, making gold more expensive. As a result the strengthening dollar is further bad news for gold.
3. The Eurozone’s deal on Greece
Now the Eurozone has agreed a new bailout package for Greece and granted a bridging loan of 6.25 billion euros, cash has been released into the country, banks have reopened and fears of Grexit have been assuaged (at least for now) and investors are adjusting their asset allocation in favour of Spanish, Portuguese and Italian bonds with higher rates of interest and away from gold.
4. China’s diminishing demand
China is the biggest consumer of gold in the world but faced with an economic slowdown the People’s Bank of China last week released data on its gold holdings which revealed that it had increased its bullion reserves but by significantly less than expected by analysts, triggering a five year low for the price of gold. Chinese investors have been offloading stocks significantly, a move which has exacerbated gold’s decline.
With none of these factors likely to change in the short term, gold’s woes look set to stay for the foreseeable future. For investors, it may be wise to adjust asset allocation but remember that, as always, diversification is the key to investment success.