Gold: Losing Its Luster

There’s nothing like a little fear and loathing for putting a shine on gold prices. Indeed, concern over everything from the U.S. economy heading into recession to the possibility of sovereign debt default in Europe has been cited as the force behind gold’s meteoric price rise, reaching a record $1,917.90 per ounce on August 23. Just one day later, gold experienced its biggest one-day drop in 18 months, with prices off about 5% at $1,763 at mid-day. The reason most commonly cited for the price decline is a collective sigh of relief as the aforementioned fears appear to be somewhat alleviated--at least for now along with probability of QE3 seeing less likely.

Traditionally, gold has been viewed as the “safe haven investment;” the place to (presumably) put your money because you’re quite certain that “Financial Armageddon” is just around the corner. The fact, however, is that while fear may spark gold’s rise, when financial calamity finally strikes, it’s usually a reason to sell, hence the old adage “buy the rumor sell the fact”. Additionally, when financial calamity hits, the owners of gold, like central banks around the globe as well as large fund managers need to sell assets to cover depreciating assets and pay liabilities and this drives gold prices lower.

Gold truly is a “buy the rumor, sell the fact” commodity. Consider what happened in 2008. During the first half of the year, gold rallied to more than $1,000 an ounce on fears of a pending crisis. When the crisis hit in the second half of the year, however, gold prices actually went down, trading below $720 an ounce.

Now, with gold having made a run at $2,000 an ounce, there just doesn’t seem to be a compelling reason for it to stay at such lofty levels. Even news of fighting in the Libyan capital of Tripoli, as rebels appeared to close in on Moammar Gadhafi--a significant geopolitical development--did not keep gold prices at their recent highs. This is all the more reason to expect that gold prices may have topped. As I see it, there are more reasons for gold to continue to drop than for it to reverse course and rally significantly again. First the reasons that gold will likely sell off:

The doom that everyone has feared actually hits, whether it’s another Euro-Zone debt debacle or fresh evidence that the U.S. economy is about to go into a tailspin. As I stated, fear bolsters the rally, but when the bad news comes into fruition, investors sell and gold drops.
The threat of doom subsides. Stocks begin to trend higher, interest rates raise a touch and gold eases under its own weight. Once again, investors sell.
The only reason that gold could keep rallying is a new perception of impending doom. I don’t believe this would work for the return of an old fear, because investors tend to shrug these things off as “Oh, that old worry is coming up again?” There would have to be a new fear factor in the market to create any significant upside potential for gold from here and one that was unlikely to materialize in the near term but create fear that it could.

Looking at the three scenarios--disaster strikes for real (sell), fear of disaster fades (sell), fear of a new disaster rattles the market (buy)--I think the shine is off gold.