We don’t typically think of summer as a hot gold-buying season. In fact, there’s usually a slump in prices, largely driven by slack demand in top gold-consumer India. This is the time Indians traditionally take a breather before a late-summer buying spree in anticipation of the fall festival season.
So, while few were surprised that gold prices dipped this week, the real news was that for a summer slump, it was atypically mild. This underlines the fact that the predictable forces that have traditionally driven gold prices are simply out the window at this point. In our new hair-trigger global economy unpredictability is rising, and the two emotions dominating markets are fear and uncertainty.
The good news for you? Gold prices always do well when uncertainty grips markets, and this time is no exception.
Pros And Cons Of Tail Risk Funds
Big ETF Buys Lifting Gold
So what happened to the traditional summer slump? This year gold exchange-traded funds (ETFs), are selling like hotcakes, driving up the price of physical gold despite the fact that ETFs, so-called “paper gold,” rarely if ever materialize as actual gold in buyers’ hands.
This raises two key issues: What’s causing this unseasonal investor rush to gold and, crucially, what do frantic buyers hope to gain?
Despite the Happy Talk, Uncertainty Dominates
Investors, particularly mainstream investors, generally don’t run for gold without being spurred by anxiety about the markets. So what’s causing investor jumpiness? In the parlance of economists, the biggest risk we face going forward is what’s referred to as systemic risk; a harmless-sounding term that means the total collapse of the banking and currency systems of an entire country. Yeah…
Systemic risk rises when banks are stuck with falling asset prices. Sound familiar? Think back to 2008—that’s what happened to banks in the U.S., which were dragged down by securitized assets filled with bad mortgages. The prices of those assets fell, which led to bank panics.
If you thought we had passed new banking regulations to reduce such systemic risk and the possibility of a bank panic, you’d be correct. Except that those rules were never fully implemented, and banks have been fighting them tooth and claw ever since they were introduced. And even if we force U.S. banks to carry more cash to cover bad assets, we can’t enforce those same rules on banks in other countries. In our globally connected economy systemic risk anywhere threatens all of us.
So this answers our first question: What’s scaring investors are unstable, over-leveraged banks, lurking like kegs of kerosene in search of a match.
Bait, Meet Switch
Which leads us to our second question: What do frantic gold ETF buyers hope to gain? Since gold buys are often driven by insecurity; lack of trust in markets and even in currency, it seems clear they’re buying in a quest for that security. But the irony is they’ve bought gold—with all the gold protection removed. While ETFs are easy to buy and sell (and to make a commission on) they’re backed by a vanishingly small amount of physical gold. In the event you need to liquidate you could find yourself fighting with hundreds of other investors for the same small bar of gold.
And while gold is legendarily impervious to stock market collapses, ETFs aren’t. Like any paper asset that “represents” value rather than having any intrinsic worth, if everybody wants to sell theirs at the same time, that price is going down. Meanwhile, the holder of physical gold finds his coins will always fetch, literally, top dollar.
Gold ETFs are great for brokers and great for markets. They’re just lousy for investors who think they’re buying a tangible asset.