Why gold is falling even as global economic fears intensify
FORTUNE – As gold plunges to new two-year lows, a paradox has emerged: The decline reflects better news in the U.S. economy, but it also suggests bad news in other parts of the world as bullion loses its luster as a safe-haven investment.
After rising for 11 consecutive years, the price of gold started falling steadily in October. Its downward spiral has intensified, with prices falling by 5% on Friday, officially entering bear market territory. The sell-off continued Monday, as prices dropped by more than 9% to $1,361.70 an ounce.
Historically, many investors think of gold as an alternative investment when economic times get tough. The precious metal soared in the years following the financial crisis and continued rising as Europe dealt with its monstrous debt problems.
Gold peaked in September 2011, trading at more than $1,900 an ounce, but prices have since fallen 24% on signs that the U.S. economy is recovering. Home prices have steadily risen. And since the start of the year, the U.S. stock market has soared to record highs as investors turned to riskier investments. But while the U.S. appears to be doing better, signs in China and Europe look so troubling that investors don’t seem very convinced gold will guard them from losses.
Last week, gold plunged on worries that debt-troubled Cyprus would sell a big chunk of its gold reserves to foot the bill for portions of a bailout. This has spurred fears that other European countries struggling with high debts, particularly Italy, Spain, and Portugal, might also sell some gold reserves.
And on Monday, the sell-off continued after China — the world’s biggest buyer of gold besides India — reported slower-than-expected growth. During the start of the year, the Chinese economy grew 7.7%, lower than the government’s targeted 8% growth rate and by far a big drop from the double-digit annual growth it had seen over three decades. Investors worried that Chinese consumers, faced with less cash, may buy less gold. What’s more, if China’s economy continues to significantly slow, it will affect economies across the world and hurt exporters of raw materials that have come to demand on surging Chinese demand over the past decade.
In a report last week, Goldman Sachs (GS) cut its three-month price target for an ounce of gold to $1,530 from $1,615 and lowered its 12-month forecast to $1,390 from $1,550. This followed Societe Generale’s April 2 note calling gold a “bubble.” The bank, along with Barclays (BCS) and Credit Suisse (CS), are among those forecasting lower average prices in 2014 than this year.
To be sure, the bearish outlook could be overblown. While Deutsche Bank (DB) last week lowered its 2013 gold forecast to $1,637, it still expects prices to average $1,810 next year.
Gold usually rises when economies aren’t doing so well, but it’s clear that hasn’t been the case when factoring in China and Europe. And the direction of prices could get more complicated. Cyprus’s plans to sell off gold reserves might have spawned investor worries that other European nations might follow, but that’s unlikely to happen, says Jacob Funk Kirkegaard, senior fellow at the Peterson Institute for International Economics.
“None of them are in the acute fiscal stress that Cyprus is at the moment, and it would send a signal of desperation to go out and suddenly sell gold,” Kirkegaard says. Admittedly, he adds, a country might decide to announce a long-term program spanning five to 10 years of prefixed gold sales, similar to what several European Union countries did years ago, but even that seems unlikely. Most European countries will have other things they can sell or privatize to come up with desperately needed cash.
In the end, whether gold will continue its downward slide could very well hinge on how well China and parts of Europe might withstand any more major problems.