The price of gold per ounce has dropped over 30%, from $1,900 to $1,235, since October 2012 . But, why is the world’s most popular precious metal investment falling so fast?

What Affects Gold Prices?

Investors usually buy gold to hedge their portfolios against catastrophes. For example, demand for gold increases during times of extreme market declines, fear of national debt defaults, currency failures, high expected inflationary periods, and times of war. You can think of gold like a fear gauge. The more fear or uncertainty in the market, the higher the price of gold; the more likely investors will want to hold onto something tangible. Yes, gold prices are affected by supply and demand, but it is also very much affected by sentiment, or speculation.

The rapid increase in gold prices over the past few years has had many features of a bubble. Gold prices were first pushed higher by the 2008 financial crisis and the European debt crisis, and then by the expansionary monetary policy set by the Federal Reserve. In fact, gold prices rose 123%, from $850 to $1,900, between 2009 and 2012.

The reason the Federal Reserve’s policies made the price of gold rise so dramatically is because investors believed the “printing” of money would spur inflation (more money chasing the same amount of goods, increasing prices). Today, we are experiencing the exact opposite; the Federal Reserve is worried about the possibility of deflation, and is also signaling the slowing Quantitative Easing (QE).

Why Are Gold Prices Dropping Now?

  • Slowing of the aggressive monetary policy by the Federal Reserve
  • Less fear and risks in the global market
  • Low inflation globally
  • Possibility of indebted governments being forced to sell gold in order to make payments (ex: Cyprus), increasing the supply of gold

Recommendation

We continue to recommend avoiding gold as an asset for your portfolio in the near term for the reasons stated above. As you can see from the graph below, gold prices have been trending with inflation, and we don’t expected an elevated level of inflation in the near future.

goldinflation

Graph by Jon Brooks, Data from the Federal Reserve

 

Jon Brooks, the “Blacksburg Whale”, does not actively trade in the stock or bond markets, and is not compensated for his recommendations. He and Bobby are not investment professionals, and their recommendations are based solely upon their own opinions.  Please see the disclaimer at the bottom of this page, and invest at your own risk.