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The Bullion Report

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September 22, 2010 in 'The Bullion Report'

Fear ItselfFear Itself

9-22-10

Fear Itself


In 1980 the price of gold soared to new highs after nearly doubling in the year prior. Thirty years later, gold prices are pushing the envelope and moving to fresh highs again. What is one of the things that this moment in price history has in common with today? Fear.

 
Past performance is not indicative of future results.
***chart courtesy Gecko Software’s Track n’ Trade Pro


Past performance is not indicative of future results.
***chart courtesy Gecko Software’s Track n’ Trade Pro

The investing climate in 1980 was one that was rife with fear-inducing fundamentals. Oil prices were high, inflation was high and the geopolitical situation was explosive. Inflation had already breached 9 percent in 1975 and by 1979 was above 11 percent. In 1980, it soared to 13.5 percent. Internationally, Iran had been bubbling with revolution for years, and the situation was far from resolved. More impactful, though, was that the Soviet war in Afghanistan was about to hit high velocity after the close of 1979. On the home front, the economy in the United States was far from comfortable. Unemployment was high, and the average consumer was struggling with higher prices for goods and energy.  

What followed was a historic price spike in gold prices, the likes of which were not seen again for another twenty years. The combination of a poor and uncertain economic outlook coupled with the rising tide of geopolitical tensions was enough to bring a flood of buyers.  The rationale was that gold provided a traditional store of wealth and value. The US dollar was already on shaky ground. It was believed that any further depreciation could drop its value and bring gold higher. Gold was not only a potential inflation hedge, it had become a crisis hedge.

Fast-forward nearly thirty years and the same kinds of catalysts for investor fear have taken root. On the global front, the war on terror continues with hot centers in Afghanistan and Iraq. Tensions in the Middle East, one of the epicenters for oil production, provide more than enough concerns that energy could be threatened. More importantly, that side of the world takes headlines regularly as Iran becomes the focus of issues concerning the potential for nuclear ambitions.

Economically, the United States has not rebounded from the fallout of the financial crises. The housing market collapse had a ripple effect that is still being felt in the employment, credit, and investment sectors. The housing industry did a 180 and the loss of income and jobs following the big boom in construction made more than a few average consumers go bust. The government response to this calamity was recovery and stimulus, the likes of which brought more than a few comparisons to the efforts to cull the effects of the Great Depression.

Fear in both instances has provided a powerful incentive to look to other stores of value beyond the equity markets and the US dollar. Commodities appear as the alternative avenue against paper IOUs. Gold has a dual life as both recognized potential currency and commodity. Unlike some of the other commodities available as an alternative to the equity markets, gold is not perishable and the supply and demand fundamentals are not as fragile. The real downside risk following a fear-induced rally comes from investor needs.

Once the news is out and the investor can find calm, there is a chance for a round of selling. However, finding the top and being motivated to sell while gold chugs towards historic highs can be a difficult maneuver. Recently, gold price came under selling pressure as investors looked to bring liquidity by selling their quality assets, including gold. This sell-off was not as deep as that seen in the 1990s when investors dropped the precious metal as rumors swirled that central banks would be selling their gold holdings. Now that the central banks have agreed to another five year cap on sales, it is unlikely that pressure would come from that quarter. Instead of a fear of gold flooding the market investors will be looking to a stable growth outlook for the economy, both at home and abroad.

The financial uncertainty still looms large over the smaller economic well-being of the average consumer as well as the powerhouse economies of nations. For now, there seems to be little to suggest that either of them is in a full recovery mode. Many nations, like Greece and Spain, have seen their economic outlook downgraded. Recent comments from the Federal Reserve suggest that the United States will have a long uphill battle with recovery and they will keep rates at historic lows to try to spur the same. Inflation fears have been on the back burner, but the amount of money and debt that were built up to try to stimulate the economy could bring that issue to the forefront sooner rather than later. Fresh fears could be just around the corner.

Summary

At both points in history, 1980 and 2010, it would appear that gold becomes a reflection of our greatest fears. Like a safety blanket, investors appear to cling to the shiny metal during times which appear dark or uncertain. While past performance is never proof positive of future outcomes, there is an appeal to gold that has outperformed other markets during fearful times. The key to these moments is to know when exhaustion has occurred, and when the fundamental and technical analysts need to take over from the human animal.

The desire of gold is not for gold. It is for the means of freedom and benefit. - Ralph Waldo Emerson


Disclaimer: The prices of precious metals and physical commodities are unpredictable and volatile. There is a substantial degree of a risk of loss in all trading. Past performance is not indicative of future results.